CONTRACTS II I. The Meaning of the Agreement (upon what did the parties agree?) A. Principles of Interpretation 1.

Before deciding whether one party or the other has fallen short in its performance of the obligations imposed under their agreement, it will be necessary for the court first to figure out just what the performance obligations of each party really are what those words and phrases should be taken to mean in the context of the agreement. a. Interpretation = the process by which a court gives meaning to contractual language when the parties attach materially different meanings to that language. i. Construction = the judicial role in determining the legal effect of K language (construction is generally incorporated in the definition of interpretation by modern K theorists). 2. Subjective Approach a. English and American courts adopted this approach from 1800 to 1875. b. Under the subjectivist view, if the parties attributed materially different meanings to contractual language, no K was formed (there was no meeting of the minds). i. Raffles v. Wichelhaus: Merchants entered into an agreement for the sale of cotton to arrive ex Peerless from Bombay. There were two ships named Peerless that were leaving Bombay: one in October and one in December. The buyer thought the shipment would be made on the October Peerless, but the seller thought the agreement was for December shipment. The buyer refused shipment, and the seller sued. The Court of the Exchequer held for the buyer because there was no consensus ad item, and therefore, no binding K. 3. Objective Approach a. Holmes (in his 1881 lectures) argued that the subjectivist approach should be abandoned in favor of the objectivist approach because: i. The subjectivist approach made enforcement of contracts too difficult, and ii. The external method was fair because a speaker should always expect his words to be understood in accordance with their normal usage. b. Williston (in his treatise and the original Restatement 230, 233) presented a systematic, objective theory of contractual interpretation: i. Words and conduct should be interpreted in accordance with the standard of a reasonable person familiar with the circumstances, rather than in accordance with the subjective intention of either party. a. This could lead to K language being given a meaning that neither of the parties intended. 4. Modified Objective Approach (modern K law) a. Corbin (in his treatise) suggested that in interpreting a K, a court should answer two questions: i. Whose meaning controls the interpretation of the K? ii. What was that partys meaning? b. R2d follows Corbins view. i. 200 states that the purpose of interpretation is the determination of meaning of contractual language.

ii. Under 201(1), if both parties do in fact attach the same meaning to a provision, that meaning will govern. a. 203 comment c: The mutual understanding of the parties controls, even if it is different from the interpretation that would be given to the K by a reasonable person. iii. 201(2): If the parties attach different meanings to their contractual language, the agreement is to be interpreted in accordance with the meaning of one party if the other party either knew or had reason to know of the meaning attached by the former. a. The crucial issue in interpreting a K is whether either party knew or had reason to know of the meaning attached to the K by the other. b. 201(2)(b) (generally approved of by courts): If either party knew or had reason to know of the meaning attached to the K by the other, the party having knowledge or reason to know is bound by the meaning of the other. 1. A party may have reason to know a meaning of a term if it is commonly used in the trade to which the party belongs or if the term is established, notorious, universal, and reasonable in itself. iv. What if a court concludes that the parties did indeed attach different meanings to a material term of the K but that neither party knew or had reason to know the meaning of the other? a. 201(3) and comment d: The result in Raffles would follow; no K exists because of the absence of mutual assent. 1. Some argue that Raffles should only apply when there is no sensible basis for choosing between conflicting meanings of the parties. v. What if both parties knew or had reason to know of each others meaning? a. Under Joyner, D wins because P must prove that D knew or had reason to know of Ps meaning and that P did not know or have reason to know of Ds meaning. c. Joyner v. Adams: A property owner sued a developer hired to subdivide undeveloped land whereby portions are deemed lots and eligible for the execution of a lot lease by a certain date. At that date, the developer had executed separate lot leases and built buildings on all lots except one, which he subdivided and graded and on which he installed water and sewer lines and roads and driveways. The property owner claimed that the developer had not fulfilled his promise because he did not find a tenant or build a building on the lot until two years after the time stated and therefore was owed escalated rent. The trial court concluded that there was no meeting of the minds on the question of what conditions would trigger the rent escalation but that the ambiguity should be resolved against D because he was the party that drafted the lease. The appellate court remanded the case for findings of fact on whether either or both parties knew or had reason to know of a different meaning attributed to the lease provision by the other party. i. Much of the evidence of the negotiations reflects directly on each partys knowledge of what the other party intended the provision to require. ii. The rule that ambiguity in K terms should be construed most strongly against the party who drafted the K was not appropriate here.

a. The rule is one of construction rather than interpretation. b. The rule is usually applied in cases involving contracts of adhesion or where one party is in a stronger bargaining position. c. Here, there is no evidence of who drafted the provision because the K was negotiated over by two sophisticated parties at arms length. iii. P can only prevail if the trial court concludes that D knew or at least had reason to know of the meaning P intended while P did not know or have reason to know the meaning D intended. a. On remand, the trial court held for D because it found that D did not know or have reason to know Ps meaning. 1. P had more than one meaning of the provision. 2. There was no evidence that Ps negotiators conveyed either of her meanings to D. 3. D flatly rejected Ps negotiators attempts to insert disputed language into the K. 4. Ds interpretation of the provision was based on common trade usage of certain terms - therefore, he had no reason to know of Ps different interpretation. 5. Maxims of Interpretation Developed Over the Years a. Noscitur a Sociis i. The meaning of a word in a series is affected by others in the same series; or, a word may be affected by its immediate context. b. Ejusdem Generis i. A general term joined with a specific one will be deemed to include only things that are like (of the same genus as) the specific one. a. Example: S contracts to sell B his farm together with the cattle, hogs, and other animals. This probably does not include Ss favorite housedog, but might include a few sheep that S was raising for the market. c. Expressio Unius Exclusio Alterius i. If one or more specific items are listed, without any more general or inclusive terms, other items although similar in kind are excluded. a. Example: S contracts to sell B his farm together with the cattle and hogs on the farm. This language would be interpreted to exclude the sheep and Ss favorite house-dog. d. Ut Magis Valeat Quam Pereat i. An interpretation that makes the K valid is preferred to one that makes it invalid. e. Omnia Praesumuntur Contra Proferentem i. If a written K contains a word or phrase which is capable of two reasonable meanings, one of which favors one party and the other of which favors the other, the interpretation will be preferred which is less favorable to one by whom the contracted was drafted. ii. This maxim is frequently employed in cases involving contracts of adhesion, where a party of lesser bargaining power accepts the K language of a stronger party, but it is not limited to such cases.

f.

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iii. Some courts have held that the maxim should be limited in its application to cases where one party can fairly be regarded as solely responsible for the language in question or where the parties are of unequal bargaining power (not to cases where sophisticated parties are represented by counsel and the K is the product of arms length negotiations). Interpret K as a Whole i. A writing or writings that form part of the same transaction should be interpreted together as a whole. ii. Every term should be interpreted as part of the whole and not as if isolated from it. Purpose of the Parties i. The principal apparent purpose of the parties is given great weight in determining the meaning to be given to manifestations of intention or to any part thereof. ii. The parties to a K necessarily have different purposes, and if these are apparent, then the court can construe a principal or common purpose from the two as a guide to the interpretation of language or the filling of gaps. a. Example: A K to buy, sell, and export scrap copper was construed to make the buyers obtaining of an export license a condition of the sellers promise to deliver. iii. However, if the purposes of the parties are obscure, the court may well fall back upon plain meaning. Specific Provision is Exception to a General One i. If two provisions of a K are inconsistent with each other and if one is general enough to include the specific situation to which the other is confined, the specific provision will be deemed to qualify the more general one (i.e., to state an exception to it). ii. Example: A lease of a truck-trailer provided that the lessee should be absolutely liable for loss or damage to the vehicle; another provision stated that no partys liability should be increased by the K. The lessee was liable for the damage because the former provision was held to be more specific than the latter and therefore, it controlled. Handwritten or Typed Provisions Control Printed Provisions i. Where a written K contains both printed provisions and handwritten or typed provisions, and the two are inconsistent, the handwritten or typed provisions are preferred. ii. This maxim is based on the inference that the language inserted by handwriting or typewriter for the particular K is a more recent and more reliable expression of the parties intentions than the language of the printed form. Public Interest is Preferred i. If a public interest is affected by the K, the interpretation or construction is preferred which favors the public interest. Reasonableness, Lawfulness, and Effectiveness are Preferred i. R2d 203(a): In interpreting an agreement, a court should prefer an interpretation that makes an agreement reasonable, lawful, and effective to

one that produces an unreasonable or unlawful result or that renders the agreement ineffective. ii. Frigaliment v. BNS: What is chicken? The court found the term ambiguous and examined conflicting evidence of usage in the trade. The court noted that there was no conflict over the fact that both parties were or had reason to be aware of the market price for old versus young chickens and that P must have expected D to make some profit from the transaction. The court concluded that Ds subjective meaning of the term chicken coincided with an objective meaning, with some trade usage, with the realities of the market, and with what Ps spokesman had said. Ps subjective meaning was contradicted only by evidence of the market prices for old versus young chickens. a. The Court ruled for D because P had failed to meet its burden of persuading the court that the term chicken should only include young chickens. l. Plain Meaning Rule i. Courts often state that the plain meaning of the language of a K should govern and that extrinsic evidence is admissible only if the court concludes that the K is ambiguous. a. Although K theorists have been practically unanimous in their rejection of the plain meaning rule, some (perhaps most) courts will nonetheless rely on the rule and refuse to receive extrinsic evidence of meaning unless the court first concludes that the agreement is ambiguous on its face. ii. K scholars (including both objectivists and advocates of a more flexible, modern approach to interpretation) have consistently rejected the idea that words can have only one precise meaning. a. Holmes said that in practice (with which theory should agree) words have more than one meaning, even in a dictionary. b. Corbin argued that a court should admit all relevant evidence of subjective intent. 1. R2d 202 adopts Corbins view on the admissibility of extrinsic evidence. a. 202(1): Under the modern theory of interpretation, a court should examine all relevant circumstances in interpreting the agreement, including preliminary negotiations and communications between the parties. i. This broad principle of admissibility is counterbalanced by the parol evidence rule. b. Definitions in Statutes or Regulations i. 201 comment c: The modern view is that definitions of terms contained in statutes or administrative regulations are not determinative of the meaning of such terms in contracts. c. Trade Usage 1. The existence of a relevant trade usage can overcome even the apparently unambiguous plain meaning of K language.

2. The court may put itself in the parties shoes and adopt their vernacular in order to accurately understand the language of sciences and trades. a. In addition to the multiplicity in meaning of words set forth in dictionaries, there are meanings imparted to them by trade customs, local uses, dialects, telegraphic codes, etc. 3. UCC 1-205 defines usage of trade and generally provides that evidence of trade usage should be relevant to the interpretation of the parties agreement. a. The Comments to 1-205 elaborate on the meaning and application of the Codes concept of trade usage and contrast it with the somewhat more restrictive view of custom as developed in the earlier common law. b. Courts applying the UCC and general contractual principles have generally allowed introduction of evidence of trade usage to interpret a term. i. However, under the Code and under the common law, a court may receive evidence of an asserted trade usage yet ultimately find that the contended usage has not been sufficiently established in fact. 4. Scholars disagree on hierarchy in which courts should give weight to different types of evidence. a. Traditionally, courts give the greatest weight to the language of the K, while according lesser significance to social norms or industry practices. b. Some believe that the hierarchy should be reversed to give preference to standards of reasonableness and good faith, default rules (gap fillers), and trade usages. i. This conforms better to the intention of the parties; K law should be viewed as public rather than private law and should reflect social principles such as good faith and fair dealing; and, from an economic perspective, law should promote social utility not private preferences. c. Others argue that norms such as trade usage, course of dealing, and course of performance should be emphasized less because they are relationship preserving, but the parties to a dispute do not usually want to preserve their relationship; they may want to maximize their gains or minimize their losses. iii. When is an agreement ambiguous? a. The Four Corners Rule 1. If a K is clear on its face, it means simply that an ordinary reader of English, reading the K, would think its application to the dispute at hand certain. 2. The text may contain clues that the K might mean something different from what it says.

3. If the language of a K appears to admit of only one interpretation, that is the interpretation that governs. 4. However, a K may be clear on its face but not resolve the issue. a. For example, the K in Raffles was unambiguous, but it did indicate which ship Peerless it referred to. b. A K may be unclear because clarity in a K is a property of the correspondence between the K and the things or activities that it regulates, and not just of the semantic surface. i. Parties to a K may be using a term that appears to mean one thing to a third party but has a special meaning known to the parties and others in their trade. b. Extrinsic Ambiguity Doctrine 1. Although a K appears to be clear, anyone who understood the realworld context would know that it does not mean what it seems to mean. 2. Objective evidence (i.e., third-party evidence) is generally admissible to demonstrate that apparently clear language means something different from what it seems to mean. a. Also, the objective evidence is first presented to the judge (in the absence of the jury) to determine whether it establishes a genuine ambiguity and whether the question of interpretation should go to the jury. 3. Subjective evidence (i.e., provided by the party himself regarding his intent) is generally inadmissible because it is inherently self-serving and difficult to verify. a. However, if the parties agree to an idiosyncratic meaning, the court will honor their agreement. b. Or, if one party charges fraud, the court will go behind the face of the K - but it will require the party to prove fraud by clear and convincing evidence (this is analogous to providing objective evidence). c. Also, if a party claims an oral modification or waiver, he may be required to back up his claim with proof of reliance, in order to give the claim greater credibility. 6. Reasonable Expectations Doctrine a. C&J Fertilizer v. Allied Mutual: A burglary insurance policy, which required visible evidence of a break-in on the exterior of the premises, was held enforceable even though the burglar made no visible damage to the exterior of a building, only to the interior of the building. The provision was in place to avoid insuring inside jobs, but there was abundant evidence that this was an outside job even though there was no exterior damage, and the definition of burglary in the policy surprised the insured. P was able to recover under the doctrine of reasonable expectations. i. The court viewed the insurance policy as a K of adhesion and cited Llewellyn for the proposition that parties only specifically assent to the dickered terms in

a K of adhesion and make a blanket assent to reasonable terms that do not alter or eviscerate the reasonable meaning of the dickered terms. ii. The dissent believed that because the K terms were not ambiguous, the court should meddle with its clearly and plainly stated meaning. b. Reasonable Expectations Doctrine (Prof. Robert Keeton): The objectively reasonable expectations of applicants and intended beneficiaries regarding the terms of insurance contracts will be honored even though painstaking study of the policy provisions would have negated those expectations. i. MAJ: More that half the states have adopted the reasonable expectations doctrine as applied to insurance policies. ii. MIN: Some courts continue to resist recognition of the doctrine. These courts will strictly enforce the words of the K, especially if there is no misrepresentation or overreaching by the insurance company and the terms are not bizarre or oppressive. iii. Modern Trend: Reject or cut back on application of the doctrine. iv. Most commentators appear to support the doctrine of reasonable expectations. c. Standard for Application of the Reasonable Expectations Doctrine (Prof. William A. Mayhew): i. The doctrine should only apply to contracts of insurance that are true contracts of adhesion; ii. In cases of ambiguity in the policy language, the policy will be interpreted in light of the objective reasonable expectations of the average insured; iii. Regardless of any ambiguity . . . the objective reasonable expectations of the average insured will be applied where the insured did not receive full and adequate notice of the provision in question, and a. the policy provision in question is unusual and unexpected, or b. the policy provision effectively emasculates the apparent coverage; iv. Where, prior to contracting for the insurance, some activity . . . which can be reasonably attributed to the insurer has created an objective impression of coverage as to a reasonable insured; and v. Where some activity reasonably attributable to the insurer prior to contracting for the insurance has caused this particular insured to reasonably believe that he has coverage, although such coverage is denied by the policy. d. Reasonable Expectations and the Ambiguity / Contra Proferentem Doctrines i. Many courts require a K to be ambiguous before they will admit extrinsic evidence to interpret the K, but most have held that extrinsic evidence is admissible to show the meaning of an ambiguous insurance policy. a. C&J Fertilizer and other cases applying the doctrine of reasonable expectations suggest that it goes beyond a mere resolution of ambiguity against the drafter. The doctrine may involve the courts refusing to apply an exclusion unambiguously stated in the policy or negating some other clearly phrased term. ii. MAJ: Most courts have held that an ambiguous policy should be construed against the insurer and in favor of the insured. a. Some scholars have questioned the wisdom of this approach to interpretation of insurance policies.

e. Application to Adhesion Contracts Generally i. Although the Restatement formulation narrows the doctrine by focusing on the expectations of the drafter, broadens the principle to cover all standardized contracts, not just insurance agreements. ii. R2d 211 comment f: a. Although customers typically adhere to standardized agreements and are bound by them without even appearing to know the standard terms in detail, they are not bound to unknown terms which are beyond the range of reasonable expectations. b. A party who adheres to the other partys standardized terms does not assent to a term if the other party has reason to believe that the adhering party would not have accepted the agreement if he had known that the agreement contained the particular term. c. Reason to believe may be inferred from the fact that the term is bizarre or oppressive, from the fact that it eviscerates the non-standard terms explicitly agreed to, or from the fact that it eliminates the dominant purpose of the transaction. The inference is reinforced if the adhering party never had an opportunity to read the term, or if it is illegible or otherwise hidden from view. iii. K of Adhesion a. The following seven characteristics define a model K of adhesion (Prof. Todd Rakoff): 1. The document whose legal validity is at issue is a printed form that contains many terms and clearly purports to be a K; 2. The form has been drafted by, or on behalf of, one party to the transaction; 3. The drafting party participates in numerous transactions of the type presented by the form and enters into these transactions as a matter of routine; 4. The form is presented to the adhering party with the representation that, except perhaps for a few identified items (such as the price term), the drafting party will enter into the transaction only on the terms contained in the document. This representation may be explicit or may be implicit in the situation, but it is understood by the adherent; 5. After the parties have dickered over whatever terms are open to bargaining, the document is signed by the adherent; 6. The adhering party enters into few transactions of the type represented by the formfew, at least, in comparison with the drafting party; and 7. The principal obligation of the adhering party in the transaction considered as a whole is the payment of money. B. Parol Evidence Rule (PER) R2d 209-18; UCC 2-202 1. Operation of the Rule a. The PER is considered by authorities on evidence and contracts to be a rule of substantive law, not a rule of evidence. i. Under ordinary rules of evidence, the right to object to inadmissible evidence is lost if not asserted at the time when the evidence is offered, but evidence

admitted in violation of the PER, even though without objection, should be disregarded if objection is made before the case is submitted to the trier of fact. ii. Federal courts are bound to follow state PER in diversity cases. b. The PER does not define what evidence is affirmatively admissible; it only operates to exclude evidenceevidence that would otherwise be admissible as rationally probative of some fact at issue. i. If the PER applies at all, it prevents one party from introducing into court extrinsic (or collateral) evidence of matters not contained in the written agreement between the parties, where that evidence is offered to supplement or contradict the written agreement. ii. Only applies to evidence that came into existence before or simultaneously with the writing. c. Procedurally, a judge will hold an in camera hearing to rule on the admissibility of the evidence before it is presented to the jury. In the absence of a jury trial, the judge will rule on the admissibility of the evidence, which determines whether he may consider it in his findings of fact. 2. Classical Approach to the PER a. Thompson v. Libby: A buyer of logs refused to pay for them, asserting a warranty on their quality that was not memorialized in the written agreement between the parties. The court held that the evidence of the warranty was inadmissible. i. Parol contemporaneous evidence is inadmissible to contradict or vary the terms of a valid written instrument. Where the parties have deliberately put their engagements into writing in such terms as to import a legal obligation, without any uncertainty as to the object or extent of such engagement, it is conclusively presumed that the whole engagement of the parties, and the manner and extent of their undertaking, was reduced to writing. a. The rule, however, does not apply where the writing is incomplete on its face and does not purport to contain the whole agreement. 1. The only criterion of the completeness of the written K as a full expression of the agreement of the parties is the writing itself (parol evidence cannot be admitted to show that the writing is incomplete and thus open to parol evidence). b. Parol evidence of extrinsic facts and circumstances would, if necessary, be admissible to apply the K to its subject matter, or in order obtain a more perfect understanding of its language. But in that case such evidence is used, not to contradict or vary the written instrument, but to aid, uphold, and enforce it as it stands. ii. The warranty was not a separate, collateral K. a. To justify the admission of a parol promise by one of the parties to a written K, on the ground that it is collateral, the promise must relate to a subject distinct from that to which the writing relates. b. Integration / Partial Integration i. In order for the PER to apply, the parties must have intended to have the terms of their complete agreement embraced in the writing.

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ii. Both classical and modern K law use the term integration to refer to a writing that is intended to be a final and complete expression of the agreement between the parties. R2d 210. a. Both classical and modern K law also recognize the possibility of a partial integration, a writing that is intended to be final but not complete because it deals with some but not all aspects of a transaction between the parties. Can parol evidence: contradict? supplement? explain? Full Integration No No Yes Partial Integration No Yes Yes

iii. Four Corners Rule / Effect of Merger Clause a. Prof. Williston argued that the question of integration must be determined from the four corners of the writing, without resort to other evidence of the actual intent of the parties about the significance of the writing. b. Williston asserted that if the writing contained a merger clause, the existence of the clause conclusively established that the writing was integrated. In the absence of a merger clause, Williston argued that the writing should be treated as an integration, unless it appeared on its face to be incomplete. 1. A merger clause states that the writing is intended to be final and complete; it is designed specifically to result in the application of the PER if extrinsic evidence is offered. 3. Modern Approach to the PER a. Many courts and the R2d have adopted this view, but some courts do not accept it. b. Taylor v. State Farm: P sued his insurance company, D, for bad faith when D settled a lawsuit against P related to a car accident outside of Ps insurance limits. D denied liability by claiming that P executed a release of all his contract claims against D in exchange for payment of uninsured motorist benefits. P claimed that the release did not cover the tort of breach of the covenant of good faith and fair dealing. The court relied on the Corbin/Restatement modern view of interpretation and the PER. It found that the release was reasonably susceptible to the interpretation that it did not apply to the tort of bad faith and the extrinsic evidence that P produced supported his contention that the release did not apply to the tort. However, there was also credible that the release did apply to the tort claim. Therefore, after ruling, as a matter of law, that the evidence was admissible, the question of the correct interpretation was a question for the jury. i. Tort of Bad Faith Refusal to Settle a Policy Claim a. Courts generally recognize that insurance companies can be liable when they refuse in bad faith to defend or settle claims brought under their policies. b. Third-Party Claims

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1. The insured seeks to recover damages from her insurer because the insurer failed to defend or settle in bad faith a claim brought by a third party against the insured. 2. The insurance company can be held liable for amounts in excess of the policy limit because of its bad faith conduct c. First-Party Claims 1. The insured seeks to recover damages because the insurance company refused to settle in bad faith a claim brought by the insured rather than a third party. 2. Courts have been somewhat more resistant to first-party than thirdparty claims perhaps because damage to the insured in a third-party claim is clear and substantial (about half of the jurisdictions have clearly recognized first-party bad faith tort claims, while only a handful has explicitly rejected the cause of action). ii. Insurance companies are required under what is known as the duty to defend provision of the typical third-party liability insurance policy to pay for defense counsel when a claim is brought against the insured. c. The court attempts to enforce the K according to the parties intent. i. Interpretation is the process by which the court determines the meaning of the words in a K. R2d 200. d. PER prohibits extrinsic evidence to vary or contradict, but not to interpret, the agreement. i. Restrictive View a. Under the restrictive plain meaning view of the PER, evidence of prior negotiations may be used for interpretation only upon a finding that some language in the K is unclear, ambiguous, or vague. b. If a writing, or the term in question, appears to be plain and unambiguous on its face, its meaning must be determined from the four corners of instrument without resort to extrinsic evidence of any nature. c. Problems with Restrictive View 1. What appears plain and clear to one judge may not be so plain to another. 2. Ambiguity determined by the judges view of clear meaning often obstructs the courts proper and primary functionto enforce the meaning that the contracting parties intended. ii. Corbin / R2d View a. Integration 1. Prof. Corbin argued that it was never possible to determine from the four corners of a writing whether or not the parties intended the writing to be an integration. i. In deciding whether a writing was intended to be integrated, a court should look not only to the terms of the writing but should also consider evidence of all the facts and circumstances surrounding the execution of the writing. ii. After hearing this evidence, the court should determine (in camera in jury cases) whether the agreement was integrated.

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2. Merger Clauses a. Prof. Corbin denied that a merger clause was determinative of the issue of integration. b. To Corbin, integration was always a question of actual intent of the parties, not a matter of some possibly fictitious intent attributed to the parties merely from an examination of the writing. c. A court should determine whether a writing is integrated by examining all facts and circumstances, not just the four corners of the writing. R2d 209(3), 214(a) and (b). i. A merger clause is not conclusive on the issue of integration but is only one factor that must be weighed with all other relevant circumstances to determine if the parties intended for the writing to be integrated. R2d 216 comment e. b. Ambiguity 1. There is no need to make a preliminary finding of ambiguity before a judge considers extrinsic evidence. R2d 212 comment b. a. Even though words seem on their face to have only a single possible meaning, other meanings often appear when the circumstances are disclosed. R2d 214(c) comment b. 2. Instead, the court considers all of the proffered evidence to determine its relevance to the parties intent and then applies the PER to exclude from the fact finders consideration only the evidence that contradicts or varies the meaning of the agreement. a. The court cannot apply the PER without first understanding the meaning the parties intended to give the agreement. b. To understand the agreement, the judge cannot be restricted to the four corners of the document. c. However, the court can only admit evidence for interpretation but not contradiction. 3. 2-Step Analysis a. First, the court considers the evidence that is alleged to determine the extent of integration, illuminate the meaning of the K language, or demonstrate the parties intent. i. The courts function at this stage is to eliminate the evidence that has no probative value in determining the parties intent. ii. The judge may admit the extrinsic evidence conditionally, reserve ruling on the issue until enough relevant evidence is presented, or if the case is being tried to a jury, consider the evidence outside the jurys presence. b. Second, the court finalizes it understanding of the K. i. Here, the PER applies and precludes admission of the extrinsic evidence that would vary or contradict the meaning of the written words. c. During either step, the judge may properly decide not to consider offered evidence because it does not aid in interpretation but, instead, varies or contradicts the written words.

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i. The more bizarre and unusual an asserted interpretation is, the more convincing must be the testimony that supports it. ii. If parties use language that is mutually intended to have a special meaning, and that meaning is proved by credible evidence, a court is obligated to enforce the agreement according to the parties intent, even if the language ordinarily might mean something different. R2d 212 comment b illus. 3 & 4. 4. Reasonably Susceptible to the Proposed Interpretation a. Although relevant, K ambiguity is not the only linchpin of a courts decision to admit parol evidence. b. The better rule is that the judge first considers the offered evidence and, if he or she finds that the K language is reasonably susceptible to the interpretation asserted by its proponent, the evidence is admissible to determine the meaning intended by the parties. R2d 215. 4. Other Approaches to the PER a. Just Outcome Approach i. In many litigated cases, it may be difficult or impossible for a court to determine the intention of the parties. Prof. Prince argues that in such cases, courts should not strain to apply principles of interpretation, but should instead strive to achieve a just result. a. Courts should weigh a number of equitable factors including: addressing public interests and public good, allowing for sharing of unanticipated losses and gains, avoiding the award of a windfall to one party at the cost of denying recovery to the other side, and considering the parties good or bad faith behavior. 5. Exceptions to the PER a. The PER does not apply to evidence offered to explain the meaning of the agreement. i. The PER only applies to written agreements that are in some sense integrated. R2d 210; UCC 2-202. a. If found to be a partial integration, the writing may not be contradicted by extrinsic evidence. R2d 213 comment b; UCC 2-202. 1. It may, however, be supplemented by additional consistent terms. b. If the writing is a complete integration, then not only may it not be contradicted, it may not even be supplemented. R2d 213(2) comment c; UCC 2-202(b). ii. Whatever the degree of integration, howeverpartial, complete, or not at alla written agreement may always be explained by extrinsic evidence. R2d 214(c). iii. Classical courts generally admitted parol evidence for explanatory purposes only if the writing appeared on its face to be ambiguous. iv. Modern courts are more likely to admit parol evidence to show that the language used in the agreement has a special meaning, even if that language

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d.

e.

does not appear unclear merely from an inspection of the writing. R2d 214 comment b. The PER does not apply to agreements, whether oral or written, made after the execution of the writing. The PER does not apply to evidence offered to show that effectiveness of the agreement was subject to an oral condition precedent. i. Even if a writing is absolute on its face, evidence may establish an oral condition to the effectiveness of the agreement, such as the condition that the agreement be approved by a third party. R2d 217. The PER does not apply to evidence offered to show that the agreement is invalid for any reason, such as fraud, duress, undue influence, incapacity, mistake, or illegality. R2d 214(d). i. Because of invalidating factors, what may appear to be a K, is not legally one, so it is not entitled to the benefit of the PER. ii. Also, whether one of these defenses applies is not likely to appear on the face of the document. R2d 214 comment c. iii. MIN: Some courts limit the fraud exception to cases of fraud in the execution (fraud in the factum). iv. MAJ: Most courts, however, will extend the fraud exception also to instances of fraud in the inducement (misrepresentations of fact that induce the other party to enter into a K). v. Some courts hold that the fraud exception only applies when the alleged fraud does not relate directly to the subject of the K. a. Sherrodd v. Morrison-Knudsen: Subcontractor, P, sued general contractor, D, to recover quantum meruit and tort damages under theories of fraud and breach of the covenant of good faith and fair dealing where D allegedly threatened not to pay P for work already done unless P signed a K and allegedly represented that a deal would be worked out to increase the payment to P beyond what was in the K. The court upheld a summary judgment for D and ruled that the fraud exception to the PER only applies when the alleged fraud does not relate directly to the subject of the K. Where an alleged oral promise directly contradicts the terms of an express written K, the PER applies. Similarly, the court ruled that a written K could only be altered by a subsequent K in writing or by an executed oral agreement. Because of the inadmissibility of Ps evidence of misrepresentations, Ps tort claim also failed. The dissent argued that the majoritys ruling defeats the purpose of the fraud exception and allows a party to defraud another with impunity so long as the fraudulent party obtains the others signature on a piece of paper. Detrimental Reliance / Promissory Estoppel i. MIN: There are a handful of cases that appear to hold that the PER does not bar a showing of extrinsic evidence that P detrimentally relied on promises or assurances not contained in an integrated written K, for the purposes of applying the promissory estoppel principle. ii. MAJ: Most cases, however, have largely rejected the use of promissory estoppel to avoid the PER.

15

f. The PER does not apply to evidence that is offered to establish a right to an equitable remedy, such as reformation of the K. R2d 214(e). i. If one party can establish that a part of the agreement was inadvertently omitted from the writing due to some mistake (perhaps the error of a scrivener, a secretary, or even a computer printer), that party may seek judicial reformation of the agreementa court order declaring that the mistakenly omitted provision will be treated in law as part of the agreement. a. Generally, however, a writing may be reformed in this fashion only if it is shown by clear and convincing evidence that the parties really did intend their written agreement to contain the term in question. g. The PER does not apply to evidence introduced to establish a collateral agreement between the parties. i. Some classical courts applied this exception only to agreements about a subject distinct from that to which the written agreement relates while others adopted a more flexible approach and allowed parol evidence even when the collateral agreement did not relate to a separate and distinct transaction. ii. R2d 216(2) provides that an agreement will not be regarded as fully integrated if the parties have made a consistent additional agreement which is either agreed to for separate consideration or is such a term as in the circumstances might naturally be omitted from the writing. iii. UCC 2-202 comment 3 indicates that consistent additional terms should be excluded under 2-202(b) only where in the courts view they would if actually agreed upon certainly have been included in the document. 6. UCC PER 2-202 a. Terms in the writing that agree or are set forth in a writing, b. Intended by the parties to be a final expression of their agreement, c. May not be contradicted: i. By evidence of any prior agreement, or ii. Of a contemporaneous oral agreement, d. But may be: i. Explained or supplemented a. By course of dealing or usage of trade or by course of performance (these can always explain or supplement the writing), and b. By evidence of consistent additional terms (subject to condition below), 1. Unless the court finds the writing to have been intended also as a complete and exclusive statement of the terms of the agreement. 7. Course of Performance / Course of Dealing / Usage of Trade a. Nanakuli v. Shell Oil: P won a breach of K claim against D by claiming that price protection was incorporated into their K even though the Ks express words allowed D to charge its posted price at the time of delivery. P argued that because all material suppliers to the trade in the area followed the trade usage of price protection, and because D had price protected P twice in the past, it should have been assumed that under the UCC, the parties intended to incorporate price protection into their K. Also, P argued that even if price protection was not incorporated into their K, D was obliged to price protect P because it was the commercially reasonable standard for fair dealing in the local trade.

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b. Relevance of Evidence i. Courts are divided on the issue of when evidence of trade usage, course of dealing, or course of performance is admissible. a. Some courts adopt a restrictive view, holding that such evidence is inadmissible if it appears to contradict the terms of the written agreement between the parties. b. Other courts have gone to the opposite extreme, holding that such evidence is almost always admissible. ii. Negating Evidence a. A clause in the K that specifically negates a particular trade usage or course of dealing may be given effect to show the parties intent to abandon past practice and avoid trade usage evidence. 1. Some scholars argue that mere boilerplate language generally negating the effect of trade usage or course of dealing should not be conclusive; to give it that effect would elevate form over the actual intent of the parties. 2. UCC 2-202 comment 2: Course of performance, course of dealing, and usage of trade are part of the agreement unless carefully negated. a. Some courts allow general language to negate such evidence. iii. Agreement means the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance. UCC 1-201(3). a. The meaning of the agreement of the parties is to be determined by the language used by them and by their action, read and interpreted in the light of commercial practices and other surrounding circumstances. The measure and background for interpretation are set by the commercial context, which may explain and supplement even the language of a formal or final writing. UCC 1-205 comment 1. iv. The express terms of the agreement and any such course of performance, course of dealing, and usage of trade shall be construed whenever reasonable as consistent with each other. UCC 2-208(2). a. Express terms shall control course of performance, course of dealing, and usage of trade. UCC 2-208(2), 1-205(4). b. Course of performance shall control both course of dealing and usage of trade. UCC 2-208(2). c. Course of dealing controls usage of trade. UCC 1-205(4). v. The agreement of the parties is broader than the express terms and includes usages, which may add terms to the agreement. a. Some courts have held that usage and dealings evidence may not only supplement or qualify express terms, but in appropriate circumstances may even override express terms. b. The usage must be sufficiently definite and widespread, and some courts require it to be proven by clear and convincing evidence. 1. Evidence of trade usage is only admissible if the party offering the evidence establishes that the usage exists

17

c. Course of Performance UCC 2-208 / R2d 202(4) i. Course of performance is the action of the parties in carrying out the K at issue, while course of dealing consists of relations between the parties prior to signing that K. a. The parties action under the agreement is the best indication of the meaning of the K. UCC 2-208 comment 1. b. A course of performance is always relevant to determine the meaning of the agreement. UCC 2-208 comment 2. ii. More than Once a. One instance does not constitute a course of performance. UCC 2-208 comment 4. b. The comments do not delineate how many acts are needed to form a course of performance. iii. Waiver a. When the meaning of the acts is ambiguous, the preference is for waiver interpretation. However, the acts must be ambiguous. UCC 2-208 comment 3. d. Course of Dealing UCC 1-205(1) / R2d 223 i. Course of dealing consists of relations between the parties prior to signing the K at issue. e. Trade Usage UCC 1-205(2) / R2d 222 i. One of the underlying purposes and policies of the UCC is to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties. UCC 1-102(b). ii. A usage of trade is any practice or method of dealing having such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed with respect to the transaction in question. UCC 1-205(2). a. A usage need not necessarily be one practiced by members of the partys own trade or vocation to be binding if it is so commonly practiced in a locality that a party should be aware of it. See UCC 1-205(3) and comment 4. iii. Definition of the Trade a. Some courts hold that newcomers to the trade are not bound by a trade usage of a term of which it was not aware. b. Some scholars have argued that if both parties to a K are members of a trade, both should be bound by usages of the trade, even if one of the parties did not know of the usage. iv. Extent of Usage (how often?) a. The existence and scope of such a usage are to be proved as facts. If it is established that such a usage is embodied in a written trade code or similar writing the interpretation of the writing is for the court. UCC 1-205(2). b. The practice must have such regularity of observance in a place, vocation, or trade as to justify an expectation that it will be observed. UCC 1-205(2). c. It is not required that a usage of trade be ancient or immemorial or universal or the like. Full recognition is available for new usages and

18

for usages currently observed by the great majority of decent dealers, even though dissidents ready to cut corners do not agree. UCC 1-205 comment 5. d. A usage of trade need not be well known, let alone universal. It only needs to be regular enough that the parties expect it to be observed. It is not necessary for both parties to be consciously aware of the trade usage; it is enough if the trade usage is such as to justify an expectation of its observance. f. Reasonable Standards of Fair Dealing in the Trade i. A price to be fixed by the seller or by the buyer means a price for him to fix in good faith. UCC 2-305(2). a. Good faith in the case of a merchant means honesty in fact and the observance of reasonable commercial standards of fair dealing in the trade. UCC 2-103(1)(b). II. Supplementing the Agreement (what does the court find to be implied in the agreement?) A. Implied Terms 1. Rationale a. Implied-in-Fact v. Implied-in-Law i. Implied-in-fact: any term that the court finds to be implicit in the parties words or conduct even though not literally expressed by them. ii. Implied-in-law: a term that the court does not find in the parties agreement, even as broadly viewed, but that the court holds should be made a part of that agreement by operation of the rules of law (statute, common law precedents, or where the court finds it appropriate) rather than by the agreement of the parties themselves. b. The court may find that a K implies these terms for reasons of business efficacy, fairness, justice, or economic efficiency. i. The general approach of courts has been to construct default rules that reflect a hypothetical bargain that the parties probably would have made had they bargained over the issue (see other views at casebook p. 525). 2. Best Efforts / Reasonable Efforts a. A lawful agreement by either the seller or buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best efforts to supply the goods and by the buyer to use best efforts to promote their sale. UCC 2-306(2). i. Some courts have suggested that either the phrase best efforts or reasonable efforts should be read to impose an obligation of due diligence or reasonable efforts. b. Wood v. Lucy, Lady Duff-Gordon: D gave P the exclusive right to use her name to endorse products in exchange for a share of the profits from sales of those products. The court found an implied promise by P to use reasonable efforts to market Ds designs because otherwise his promises to pay her the profit share and to account to her monthly regarding sales would be worthless. The court interpreted the transaction to have business efficacy and not to put one party at the mercy of another.

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i. One scholar has argued that agreements in which one party makes nonbonding, illusory promises should be enforced because the other party may have in effect bargained for a chance to show that his performance is attractive. a. This would be similar to someone selling goods with a money back guarantee or under a sale on approval condition in UCC 2-326. b. The scholar further argues that if the party were deceived into believing that he had actually received a true promise in return, the agreement should not be enforced due to unconscionability. ii. Or, possibly the party bargained for the opportunity to say Im represented by XYZ, a respected agent, which may give the party credibility (a benefit). 3. Reasonable Notification of Termination a. Termination of a K by one party except on the happening of an agreed event requires that reasonable notification be received by the other party and an agreement dispensing with notification is invalid if its operation would be unconscionable. UCC 2-309(3). i. Reasonable notice of termination without cause takes into account time needed to: a. Recoup reasonable initial or continuing investment; b. Close out product line; c. Minimize losses; and d. Find a substitute arrangement. ii. Determination whether notice is reasonable may also be affected by terms contained in the parties present or prior agreement and by industry standards. b. Leibel v. Raynor: D, a garage door manufacturer, terminated an oral exclusive distributor agreement with P with no advance notice. The court held that reasonable notification is required in order to terminate an on-going oral agreement for the sale of goods in a relationship of manufacturer-supplier or dealer-distributor or franchisee. The court recognized that a distributorship agreement was an agreement for the sale of goods subject to Article 2 of the UCC and not a services K. The court vacated a summary judgment for D and concluded that the length of time sufficient to constitute reasonable notice was a question of material fact. 4. Other UCC Implied Terms a. As a matter of law, these terms (like reasonable notice of termination) will be implied in a K for the sale of goods unless otherwise agreed by the parties: i. Place of Delivery UCC 2-308 ii. Time of Payment UCC 2-310 iii. Risk of Loss UCC 2-509 iv. Buyers Right of Inspection UCC 2-513 b. Most UCC rules are gap fillers subject to preemption by the parties express agreement, but some implied-by-law obligations imposed by the UCC are mandatory and may not be varied even if the parties expressly agree otherwise (e.g., UCC 2-309(3), 2-719(3), 1-102 and comments 2 and 3). B. Implied Warranties 1. Caveat Emptor (let the buyer beware)

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a. The seller bore no responsibility at all for the quality of the product he was selling unless he expressly guaranteed it or gave a warranty to the buyer. b. This doctrine was established in 1603 in England and adopted by American courts in the nineteenth century. c. In the last quarter of the nineteenth century, American courts, responding to changing market conditions, gradually reversed the rule of caveat emptor by imposing obligations on the seller as to the quality of goods sold. i. These obligations, or implied warranties, were not based on actual agreement of the parties but were instead imposed by law on the seller. 2. Applicability of UCC / Common Law Warranties a. UCC Article 2 only applies transactions in goods, UCC 2-102, it does not apply to transactions that deal purely with services or real estate. i. The key element in defining goods under UCC is movability at the time of identification to the K. UCC 2-105(1). b. In cases where the UCC does not apply, an express warranty may still arise by agreement of the parties, and a court could create an implied warranty as a matter of common law. c. Mixture of Goods and Services i. MAJ: Most courts have adopted a predominant factor test in deciding whether to apply the UCC to transactions that involve both goods and services. Under this test, if goods are the predominant factor in the transaction, the UCC is applicable. This test considers: a. The relative cost of the goods and services; b. K language and whether it suggests that the parties were bargaining primarily for goods or services; ii. Some courts have used a gravamen of harm test, which focuses on whether the source of the alleged breach is the goods portion of the transaction. d. Leases i. UCC Article 2A covers leases and includes express and implied warranty provisions similar to Article 2. ii. While widespread adoption of Article 2A effectively removes the need to determine whether leases come within the scope of Article 2, parties occasionally dispute whether a transaction is a sale or a lease. e. Software i. MAJ: A majority of courts faced with the question whether transactions involving software fit within the scope of Article 2 have held that Article 2 does not apply to licenses or sales of software. ii. A proposed Article 2B to address transactions in software and establish model rules for electronic transacting has been delayed. f. Blood Products i. There is disagreement whether blood transfusions are part of medical services or goods subject to UCC Article 2 and, therefore, the implied warranties of merchantability and fitness for a particular purpose (especially when the recipient contracts AIDS or hepatitis from the transfusion).

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ii. Most states have passed blood shield statutes that preclude actions based on breach of implied warranties or tort strict products liability but that do allow actions based on negligence or battery (for failure to obtain consent). g. Commercial Providers of Services i. In the absence of statutory protection (such as blood shield laws), courts have often been willing to hold commercial providers of services liable for breach of implied warranty or on similar tort theory. a. By contrast, courts have been unwilling to impose warranty liability on providers of professional services, limiting liability of professionals to negligence (failure to exercise the skill and care ordinarily possessed by members of the profession or, if the professional is a specialist, of specialists in the field) or breach of express promises. 1. However, professionals may be fiduciaries of their clients and owe duties of loyalty, fairness, and candor. 3. Express Warranties a. Under UCC 2-313, a seller can make an express warranty in several ways: by words, description, sample, or model. i. The section does not require the seller to have the intent to create an express warranty. b. Puffing i. An affirmation merely of the value of the goods or a statement purporting to be merely the sellers opinion or commendation of the goods (sales talk or puffing) does not create a warranty. UCC 2-313(2). ii. Factors to consider in deciding whether statements amount to warranties or puffing: a. The specificity of the representations; b. The degree to which the seller qualifies or hedges his statements; c. The experimental nature of the product; and d. The buyers knowledge, including expertise that the buyer may have. c. Reliance by Buyer i. Under pre-UCC law, it was clear that the buyers reliance on affirmations or promises made by the seller was necessary for the creation of an express warranty. a. Whether reliance is required under the UCC is unclear. 1. Under UCC 2-213, an affirmation, promise, description, sample, or model will amount to an express warranty if it is part of the basis of the bargain. 2. MIN: Some courts have held that the UCC continues to require the buyers reliance for creation of an express warranty, perhaps with a shifting of the burden of proving lack of reliance to the seller. 3. MAJ: Most courts and commentators, however, have asserted that the UCC eliminates the reliance requirement. 4. The draft version of revised Article 2 403(c) provides that a representation (including public advertising) made to the immediate buyer becomes part of the basis of the bargain unless: a. The immediate buyer knew that the representation was not true;

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b. A reasonable person in the immediate buyers position would not believe that the representation was part of the agreement; or c. The immediate buyer did not know of the representation at the time of sale. d. Limitation of Liability i. Typically, standard warranties attempt to limit the manufacturers warranty liability to repair or replacement of the defective product by excluding liability for damages. 4. Implied Warranty of Merchantability a. A merchant who regularly sells goods of particular kind impliedly warrants to the buyer that the goods are of good quality and are fit for the ordinary purposes for which they are used. UCC 2-314. i. Most of the 2-314 cases in which courts have found breaches of the warranty of merchantability involved goods that because of their defects either did not work properly or were unexpectedly harmful. ii. P (the buyer) must establish: a. There has been a sale of goods that are not merchantable; b. The seller is a merchant with respect to goods of that kind; and 1. A merchant is a party who regularly deals in goods of the kind or holds himself out as having particular knowledge about the kind of goods. UCC 2-104(1). c. The defect in the goods caused damage to P. 1. The breach must be the proximate cause of the loss sustained. UCC 2-314 comment 13. b. Disclaimer (As Is Clause) i. The seller may be able to disclaim this warranty with appropriate language in the K. UCC 2-316. a. Implied and express warranties may overlap, and a clause disclaiming warranties may be effective for implied warranties but not for express warranties. ii. Disclaimer and Tort Liability a. A defective product that causes personal injury might give rise to tort liability, even if the sellers implied warranty of merchantability had been effectively disclaimed. 5. Implied Warranty of Fitness for a Particular Purpose a. This warranty is created only when the buyer relies on the sellers skill or judgment to select suitable goods and the seller has reason to know of this reliance. b. Breach of the warranty does not require a showing that the goods are defective in any waymerely that the goods are not fit for the buyers particular purpose. UCC 2-315. c. Exceptions i. If the buyer insists on a particular brand, he is not relying on the sellers skill and judgment and so no warranty results. UCC 2-315 comment 5. ii. MAJ: Most courts hold that the buyers particular purpose must be one other than the ordinary use of the goods.

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6.

7.

8.

9.

a. MIN: Some courts hold that the fitness warranty applies even if particular use is same as general use. Implied Warranties of Title a. Under UCC 2-312, the seller makes a warranty of good title, a warranty of freedom from encumbrances, and a warranty against infringement. i. If a dealer in artwork sells a painting that turns out to be stolen, the buyer (even a good faith purchaser for value see UCC 2-403) will not acquire a title good against the true owner. ii. However, under UCC 2-312(1)(a), the buyer may recover against the dealer for breach of the implied warranty of title. iii. Similarly, if a software manufacturer sells a computer program, the customer would have a claim for breach of warranty against the manufacturer if the program infringed on the copyright of another manufacturer. UCC 2-312(3). Warranties in Leases a. A lease is generally defined in UCC 2A-103(j) as the right to possession and use of goods for a term in return for consideration whereas a sale contemplates permanent transfer of rights in the goods. b. Consumer Leases i. Involve goods leased primarily for personal, family, or household use by a person who regularly leases goods. UCC 2A-103(e). c. Finance Leases i. Elements a. Lessee selects the goods from a third-party supplier; b. Lessor acquires the goods for the purpose of leasing them to the lessee; and c. Lessee is aware of the warranty provisions in the K between the supplier and the lessor. ii. In a finance lease, the lessee almost always receives warranty protection from the supplier rather than the finance lessor. UCC 2A-209. d. Similarity to Article 2 Warranties i. The provisions of Article 2A largely mirror those of article 2 on express warranties (UCC 2A-210), implied warranty of merchantability (UCC 2A212), implied warranty of fitness for a particular purpose (UCC 2A-213), and the warranty against interference or infringement (UCC 2A-211). Warranty of Habitability a. MAJ: The overwhelming majority of states recognize an implied warranty of habitability in residential leases by virtue of legislative or judicial action. b. Uniform Residential Landlord Tenant Act 2.104 accepts the concept of warranty of habitability and defines the landlords obligations (see casebook pp. 530-31). Housing Merchant Warranties a. MAJ: A clear majority of jurisdictions have recognized an implied warranty of quality in the sale of a new home by a builder-vendor. This warranty implies a term in the express K between a builder-vendor and purchasers of a home that the house will be constructed in a skillful manner free from material defects. b. Warranty of Habitability

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c.

d.

e.

f.

g.

h.

i. This warranty reflects the end result expectation that the home will not have any major defects that render it unsuitable for habitation. Warranty for Skillful Construction i. Some courts recognize a warranty for skillful or workmanlike performance that focuses on the manner in which work is done and covers defects that do not render the house inhabitable. Disclaiming the Warranty i. The prevailing view is that the implied warranty of habitability may be modified or disclaimed. a. Many courts, however, view disclaimers with suspicion and will refuse to enforce a disclaimer unless it is conspicuous, specific, and the result of mutual agreement. ii. Disclaimers and Duties to Disclose / Inspect a. Some courts hold that an as is disclaimer is ineffective when the seller has a duty to disclose information not accessible to a diligent buyer. b. Some courts hold that an as is disclaimer is effective if the purchaser fails to exercise his right to conduct expert inspections. iii. Tort Liability a. A defective product that causes personal injury might give rise to tort liability, even if the sellers implied warranty of merchantability (or habitability) had been effectively disclaimed. Privity of K i. A number of courts have extended the implied warranty even though there is no privity of K between the subsequent purchaser and the builder-vendor. a. Not all courts, however, are willing to allow subsequent home purchasers to maintain an action for breach of implied warranty. ii. Some courts have recognized an implied warranty of quality for major improvements to an existing home which extends to subsequent purchasers. Non-Builder Liability i. Some courts have allowed homebuyers to maintain actions against nonbuilder owners or financial institutions for defects in the property. a. Most courts limit liability of lenders to situations in which their role goes far beyond that of a usual lender and they have become in essence joint venture partners with the builder. Commercial Real Estate i. Courts are divided whether they should imply a warranty of habitability in the sale of commercial rather than residential real estate Caceci v. DiCanio Construction: A builder was liable to a home purchaser for building a house on soil composed of deteriorating tree trunks, wood, and other biodegradable material, which caused the house to sink, under an implied warranty of workmanlike construction. i. The builder-sellers knowledge of the defect was not decisive under this implied warranty (while it may have been relevant in a fraud claim). ii. A standard merger clause was of no legal effect regarding an implied warranty with respect to latent defects.

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iii. The party best able to prevent and bear the loss should be liable; the builder is in a superior position to prevent major defects, and the buyer is unable to inspect the property until after the K is executed and the property is built. C. The Implied Obligation of Good Faith 1. UCC / Common Law Rules a. Every K or duty within the scope of the UCC imposes an obligation of good faith in its performance or enforcement (not generally applicable to formation or negotiation of a K). UCC 1-203. b. Every K imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement. R2d 205. 2. Definitions of Good Faith a. Device for Protecting the Bargain i. Good faith performance or enforcement of a K emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party. R2d 205 comment a. ii. Obligation of good faith should be employed in cases where one partys actions, although not expressly forbidden (and perhaps even expressly permitted) by the K, undermine the spirit of the agreementeither by enabling that party to realize gains that in making the K he had implicitly agreed to surrender, or by unfairly denying the other party the fruits of the K that he reasonably expected to receive. R2d 205 comment d. iii. Subterfuges (deception) and evasions violate the obligation of good faith even though the actor believes his conduct to be justified. R2d 205 comment d. iv. One method of analyzing the covenant of good faith is to ask what the parties likely would have done if they had considered the issue involved. b. Two UCC Definitions i. UCC 1-201(19) defines good faith simply as honesty in fact. ii. UCC 2-103(1)(b) provides that at least where merchants are concerned, good faith requires not merely honesty but also the observance of reasonable commercial standards of fair dealing in the trade. c. Good Faith = Absence of Bad Faith i. Good faith excludes a variety of types of conduct characterized as involving bad faith because they violate community standards of decency, fairness, or reasonableness. R2d 205 comment a. Examples include: a. Concealing a defect in a product; b. Willfully failing to perform in full but otherwise substantially performing; c. Openly abusing bargaining power to coerce an increase in price; d. Hiring a broker and then deliberately preventing him from consummating the deal; e. Consciously lacking diligence in mitigating the other partys damages; f. Arbitrarily and capriciously exercising a power to terminate a K; g. Adopting an overreaching interpretation of K language; h. Harassing the other party for repeated assurances of performance; i. Discriminating against a party to a K because of such factors as sex, race, religion, ethnicity, sexual orientation, disability, or age. 3. Tort Action under Insurance Ks (See Expectation Damages)

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a. MAJ: In almost every state, tort actions have been recognized against insurance companies for bad faith refusal to honor obligations under insurance Ks, with the result that the injured party could seek both actual and punitive damages. b. MIN: More controversial has been the issue of whether the tort of bad faith breach of K should apply to commercial K in addition to insurance Ks. c. Some states allow an action for tortious breach of the covenant of good faith only where a duty exists independently of the duty to perform under the K (e.g., a fiduciary relationship). 4. Requirements / Output Ks a. Theoretical Problems with Requirements / Output Ks i. Lack of Consideration a. Prof. Corbin, who asserted that consideration existed because of the commitment by the buyer to either buys goods from the designated seller or not by at all, effectively met this problem. R2d 77. 1. Either buying from the designated seller or not buying at all would be sufficient consideration if bargained for separately. R2d 77 comment b. b. Today, under the UCC, an agreement that does not to some appreciable degree bind the buyer to buy only from the particular seller is likely to be viewed as invalid and unenforceable, because lacking in consideration or mutuality of obligation. 1. However, some courts may find an implied promise of exclusivity. 2. Or, a court may find consideration or promissory estoppel apart from the buyers executory promise. ii. Lack of Mutuality a. Courts increasingly are willing to consider mutuality of obligation as a mere corollary to the consideration rule with no independent force. iii. Lack of Definiteness a. Sufficient information is usually available from the buyers past history, the parties estimates, a prior course of dealing, or their course of performance under the agreement at issue. b. Good Faith in Requirements / Output Ks (both types of K treated similarly) i. In addition to duty to exercise reasonable / best efforts (because of exclusivity), there may be a duty of good faith in requirements / output Ks. ii. A term which measures the quantity by the output of the seller or the requirements of the buyer means such actual output or requirements as may occur in good faith, except that no quantity unreasonably disproportionate to any stated estimate or in the absence of a stated estimate to any normal or otherwise comparable prior output or requirements may be tendered or demanded. UCC 2-306(1). iii. Overdemanding / Underdemanding a. MAJ: Overdemanding should be treated under a literal interpretation of the provision, and underdemanding should be treated under a good faith rule: good faith variations from prior requirements are permitted even when the variation may be such as to result in discontinuance. UCC 2306 comment 2.

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1. Underdemanding (MAJ rule, good faith rule) a. A buyer may reduce his requirements to zero if he was acting in good faith, even though the K contained an estimate of those requirements (and as long as he does not buy from anyone else). b. C/L rule: The seller assumes the risk of all good faith variations in the buyers requirements even to the extent of a determination to liquidate or discontinue the business. c. Detrimental Reliance by Supplier i. The statement of an estimate invites the seller to begin making preparations to satisfy the K, and a seller is entitled to expect that the buyer will buy something like the estimated requirements unless it has a valid business reason for buying less. 2. Overdemanding (MAJ rule, literal rule) a. The unreasonably disproportionate and possibly good faith provisions do not allow a purchaser to buy so much from a seller at the K price that he could re-sell the products and, in effect, go into competition with his supplier or stockpile goods. b. MIN: Both overdemanding and underdemanding should be treated the same: the agreed estimate is to be regarded as the center around which the parties intended the variation to occur. UCC 2-306 comment 3. iv. Showing of Good Faith to Underdemand a. The essential ingredient of good faith in the case of the buyers reducing his estimated requirements is that he not merely have second thoughts about the terms of the K and want to get out of it. b. A purchaser would clearly be acting in bad faith if it bought requirements from another supplier, made its own, or reduced purchases to hurt the supplier, with whom it competed in other areas. c. A purchaser would clearly not be acting in bad faith if it had a business reason for deciding not to buy requirements independent of the terms of the K or any other aspect of the relationship such as a drop in demand for its products or abandoning or closing the division that used the requirements. 1. A shut-down by a requirements buyer for lack of orders might be permissible where a shut-down merely to curtail losses would not. UCC 2-306 comment 2. v. Empire Gas v. American Bakeries: D entered into a K with P to purchase approximately 3,000 propane conversion units, more or less depending on Ds requirements, and promised to purchase propane solely from P for four years, provided Ps price remained reasonably competitive. Without providing a reason, D failed to order any units. The court held that Ds failure to provide any reason for failure to order units would allow a reasonable jury to infer that it acted in bad faith when P showed that D continued to own its fleet of trucks and had the financial wherewithal to execute the K. 5. Discretionary Rights

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a. Where a K confers on one party a discretionary power affecting the rights of the other, a duty is imposed to exercise that discretion with honesty and good faith and fair dealing not to frustrate the other partys rights to receive the benefits of the K. i. Honesty a. When it is a condition of an obligors duty that he or she be subjectively satisfied with respect to the obligees performance, the subjective standard of honest satisfaction is applicable. R2d 228 comments a, b. 1. See Express Conditions for objective standard applicable to satisfaction. ii. Good Faith and Fair Dealing a. Where the K involves matters of fancy, taste, or judgment, the promisor is the sole judge of his satisfaction. If he asserts in good faith that he is not satisfied, there can be no inquiry in the reasonableness of his attitude. b. Exception for Actions Allowed by Express Terms of the K i. Parties may, by express provisions of the K, grant the right to engage in the very acts and conduct that would otherwise have been forbidden by an implied covenant of good faith and fair dealing. c. Locke v. Warner Bros.: D entered into a development agreement with P where it had the first option to produce any film of her film projects after which P was free to market them to other studios. Unbeknownst to P, D was reimbursed for the compensation paid to P under the development by Ps former boyfriend. P claimed that the development agreement was a sham and that D never intended to produce any of her works. The court reversed summary judgment for D on the issues of breach of K because evidence showed that D may have violated the implied obligation of good faith and fair dealing and fraud because evidence existed that D expressed an absolute unwillingness to consider Ps projects, from which it may be implied that D never intended to give Ps projects a good faith consideration. 6. Lender Liability a. Lenders typically have express terms in their agreements with borrowers that allow them to terminate credit or any obligation to extend additional funds, accelerate debt in certain circumstances, and foreclose on collateral in case of default. b. Good Faith i. When a secured party has the right under a security agreement to accelerate at will or when he deems himself insecure, acceleration must be made in good faith. UCC 1-208 (but see comment below on demand instruments). ii. MAJ: A majority of courts hold that the duty of good faith imposes no restriction on a lenders demand for payment under a demand instrument. a. The official comment to UCC 1-208 states that the obligation of good faith has no application to demand instruments whose very nature permits call at any time with or without reason. c. SPLIT: Advance Notice and Reasonable Termination of Credit i. Express Terms Govern

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a. Many courts enforce express terms allowing termination of credit at the discretion of the lender without advance notice under the position that the implied covenant of good faith cannot limit express rights in a K, even if the conduct appears opportunistic. ii. KMC v. Irving Trust: Advance Notice / Reasonable Termination Required a. The court ruled that a lender has an obligation to provide prior notice of its intent to cut off credit under the implied duty of good faith absent valid business reasons precluding the lender from doing so. b. The court also required that the lenders termination of funds have some objective basis upon which a reasonable loan officer in the exercise of his discretion would have acted in that manner. 7. Employment-At-Will a. Contractual Relationship (what kind of employment arrangement?) i. At-Will a. Employment of an indefinite duration is presumed to be at-will, meaning either party is free to terminate the K at any time without a requirement of good or just cause. ii. Term Employment a. A K that includes a specified duration is construed to mean that the employee may be terminated only for just or good cause. b. An agreement for a term must be specific to overcome the presumption of at-will employment. iii. Permanent Employment a. An employer and employee may have an express agreement that, although for an indefinite period of time, provides that the employee can be terminated only for just or good cause. b. Even if interpreted literally, promises of permanent employment have customarily been held to be unenforceable unless supported by some additional consideration beyond the employees performance of his duties on the job. 1. MIN: Although most jurisdictions hold otherwise, some courts find this additional consideration in the employees giving up prior, secure employment, at least where the promise of permanent employment was bargained for. 2. MIN: Some courts do not require any additional consideration. iv. Implied-in-Fact Good Cause Provision a. Some courts recognize a cause of action for breach of K when an employer commits itself, by public statements in personnel manuals or otherwise, to refrain from terminating employees except for good cause. 1. Some courts may find representations in an employment manual may offer a unilateral K that may be accepted by the employees remaining on the job. b. Not all courts agree, however, that statements of job security made in policy manuals are contractually binding. c. The inclusion of a boilerplate disclaimer in an employee manual stating that the document does not create a binding obligation will not necessarily

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be effective, but perhaps a conspicuously placed, bold and large printed, unambiguous claimer would be. b. Termination Under an At-Will Arrangement i. Termination and demotion or reduction in duties and pay may be treated similarly. ii. Under the employment-at-will doctrine, an employer may dismiss employees without cause regardless of motive: for its own legitimate business reasons or even highly subjective reasons, such as dislike, hatred, or ill will. iii. SPLIT a. MIN: Under the covenant of good faith and fair dealing, two states (MT, AK) effectively require good cause for termination of at-will employment. b. MIN: Other courts, however, have held that the implied covenant of good faith imposes no limit on at-will employment contracts. c. MAJ: Some courts hold that an at-will employment K is terminable by either party for any reason not motivated by bad faith. c. Breach of Good Faith in At-Will Employment i. To constitute a breach of the implied covenant of good faith, the conduct of the employer must constitute an aspect of fraud, deceit, misrepresentation, or violation of public policy. ii. Public Policy a. Whether by tort or a breach of K, employees who seek protection from firing on the basis that their actions were protected by a public policy must assert a public interest recognized by some legislative, administrative, or judicial authority. 1. Examples: firing an employee for refusing to commit perjury or sign an untrue statement, for refusing to violate his professional ethical duties (e.g. an attorney reporting another attorneys misconduct), or for refusing sexual demands of an employer (does not generally include uncovering internal business or financial practices of the employer). b. Some courts do not allow a tort action for wrongful discharge if a federal or state statute provides a separate cause of action for the same conduct. 1. Some courts hold that rights to sue for both claims are cumulative. c. MAJ: A clear majority of jurisdictions recognize an action for wrongful discharge when an employee is fired for engaging in conduct that is authorized or protected by statute. 1. MIN: Some courts do not recognize a cause of action for wrongful discharge in at-will employment. iii. Misrepresentation a. The employer is liable for misrepresenting some important fact, most often the employers present intentions, and the employee relies thereon either to accept a new position or remain in a present one. b. Promissory estoppel may also give relief to a discharged employee in addition to a claim for bad faith if the employee reasonably relied on an employers promise to his detriment. iv. Discharge to Avoid Payment of Benefits

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a. An employee has a cause of action when an employer uses it superior bargaining power to deprive an employee of compensation that is clearly identifiable and is related to the employees past service. b. Example: firing an employee after he made a big sale but before being paid his commission. v. Deceit and Subterfuge a. An employer is liable if it intentionally creates false grounds and manufactures a distorted record in order to establish a fictitious basis for termination. d. DuPont v. Pressman: D terminated P after Ps supervisor falsified and manipulated Ps record to create fictitious grounds to terminate P in retaliation for Ps questioning his supervisor about an apparent conflict of interest between the supervisor and D. The court ruled that deceit in falsifying Ps recordbut not ill will or hatredwas an actionable violation of the covenant of good faith. III. Avoiding Enforcement A. Minority and Mental Incapacity 1. Quite early, the C/L declared that certain classes of persons lacked capacity to contract (minors, or infants, married women, slaves, African-Americans, AsianAmericans). Civil rights laws have removed race- and sex-based restrictions on ability to contract. 2. Minors a. MIN: Traditional Rule i. When the court can pronounce the K to be in the infants prejudice, it is void; ii. When to his benefit, as for necessaries, it is good; and iii. When the K is of any uncertain natureas to benefit or prejudiceit is voidable only, at the election of the infant. b. MAJ: Modern Rule i. All minors Ksregardless of whether the court views them as to his benefit or prejudiceare voidable (but not void) at the election of the minor up to the beginning of the day before the partys 18th birthday. R2d 14. ii. Upon reaching the age of majority, the minor has the power to affirm the K, in which event the minor is bound. a. On reaching the age of majority, the minor must act within a reasonable period of time to disaffirm the K or he will be deemed to have affirmed the transaction. c. MIN: Benefit Rule i. Upon rescission, recovery of the full purchase price is subject to a deduction for the minors use of the merchandise. d. MIN: Deterioration Rule i. The minors recovery of the full purchase price is subject to a deduction for the minors use of the consideration he or she received under the K, or for the depreciation, deterioration, and willful or negligent damage of the consideration in his or her possession. ii. Some courts only apply this rule if the minor misrepresented his age or willfully destroyed the property. e. MIN: Return of Consideration

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i. Upon rescission, some courts require return of only the consideration remaining within the minors control. f. Limitations on Benefit / Deterioration Rules i. Benefit / Deterioration rules may be limited to situations where: a. The minor has not been overreached in any way; b. There has been no undue influence; c. The K is fair and reasonable; or d. The minor has actually paid money on the purchase price and has taken and used the article purchased. g. Necessaries i. The minor is liable for the reasonable value of necessaries based on quasi-K relief rather than enforcement of the actual K. R2d 12 comment f. a. Housing is not always a necessary (and even if it were, the minor would only be liable for the reasonable value of it rather than the K rent); therefor, a landlord may require a court decree of emancipation before renting to a minor. h. Tortious Conduct by Minor i. A minors ability to disaffirm may be restricted if the minor engages in tortious conduct such as misrepresenting his age or willfully destroying goods. ii. MAJ: Minor who misrepresents his age can still disaffirm the K but may be liable in tort for fraud. i. Minors Executing Release of Liability / Settlement Agreements i. Many courts have held that minors are able to disaffirm prospective releases that attempt to insulate another party from liability in activities such as skiing, soccer, or little league. a. SPLIT: Courts disagree whether parents have the capacity to execute a prospective release on behalf of their children. ii. Courts also have tended to allow minors to disaffirm post-injury settlement agreements. a. Pennsylvania courts have enforced post-injury settlement agreements when the minor has received the benefits therefrom. j. Disaffirming Not Allowed Under Statute i. Insurance Ks by emancipated minors (CA). ii. Savings accounts permitted for minors (MI). iii. Education loans may not be disaffirmed (NY). k. Emancipation by Marriage i. SPLIT: Courts disagree whether marriage automatically dissolves inability to enter into Ks). 3. Mental Incapacity a. Presumption of Competency / Burden of Proof i. The law presumes that every adult person is fully competent unless the person seeking to void the K meets the burden of proving otherwise. b. Standard for Incompetence i. Time for Determining Competency a. Competency is determined as of the date of the transaction. ii. Cognitive Test

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c.

d.

e. f.

g.

a. A person is incompetent if he is unable to understand in a reasonable manner the nature and consequences of the transaction. R2d 15(1)(a). iii. Volitional Test (alternative test) a. A person is incompetent if he is unable to act in a reasonable manner in relation to the transaction and the other party has reason to know of this condition. R2d 15(1)(b). iv. Guardianship / Conservatorship a. Statutes provide means for a court, on petition of family members or other interested parties, to declare a person legally incompetent and appoint a guardian or conservator to care for the incompetents person or property. b. General Rule: A person does not have the capacity to enter into Ks if the persons property is under guardianship. R2d 13. 1. There may be possibility in some cases of restitutionary liability or liability for necessaries contracted for and received by the adjudicated incompetent. General Rule (not applicable to guardianship situations) R2d 15(1) i. MAJ: The vast majority of courts have held that an incompetent persons transactions are voidablethe incompetent has the power to void the K entirely (subject to the limitations below regarding obligation to restore consideration). ii. Some courts recognize a cause of action to rescind a K or conveyance based upon the lack of mental competency at the time of the transaction (not just an affirmative defense based on lack of capacity). Exception: Obligation to Make Restoration of Consideration R2d 15(2) i. MAJ: If the K is made on fair terms and in good faith and the other party has no reason to know of the incompetency, the K ceases to be voidable where performance in whole or in part changes the situation such that the parties cannot be restored to their previous positions. R2d 15(2). a. Fair Terms b. Good Faith (may be linked to fair terms and/or knowledge of incompetency) 1. Party contracting with an incompetent person must show good faith in formation of the K (not talking about performance of the Kthis is different from traditional UCC / C/L rules). c. No Knowledge or Reason to Know of Incompetency d. Injustice / Impossible to Restore to Previous Conditions. Necessaries / Possibility of Disaffirmance or Ratification i. Same rules as above for minors. Americans with Disabilities Act (ADA) i. Prevents discrimination against those with, with a record of , or regarded as having a disabilityshould the ADA prevent someone from contracting with another party that has a history of mental illness? Intoxicated Persons i. A K is voidable if a party has reason to know that because of intoxication the other person is unable to either understand the transaction or act in a reasonable manner. R2d 16.

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B. Duress and Undue Influence 1. Physical Compulsion a. Where a party manifests assent as a result of a threat to life or limb, the result is a void K. R2d 174. 2. Non-Physical Duress (including Economic Duress, or Business Compulsion) a. General Rule i. Ks made under duress, other than physical compulsion, are deemed voidable rather than void. Such Ks are binding unless disaffirmed and may be expressly or implicitly ratified by the purported victim. b. Basic Elements R2d 175. i. A wrongful, unlawful, or coercive act or threat; a. The act may be tortious, illegal, immoral, or in bad faith. The threat may be to commit a crime or tort or threats of criminal prosecution. R2d 176. 1. A threat of criminal prosecution by a lawyer to gain an advantage in a civil case may be considered extortion or may be a violation of professional ethics. 2. A threat is improper if the threat was for an illegitimate end and the resulting agreement did not involve a fair exchange. R2d 176(2). b. A threat to breach a K, withhold payment of an admitted debt, or to engage in litigation may wrongful if done in bad faith. c. Clean Hands: Alleged Victims Role in Creating His Own Difficulties 1. MAJ: The fact that a party agreed to a settlement because of a desperate need for cash could not be the basis for duress unless the other side had caused the financial hardship. 2. MIN: It is enough that one party takes advantage of the other sides dire circumstances without having caused the financial hardship. d. A number of courts have concluded that particular divorce agreements were voidable because of duress exerted by one former spouse against another, for example: threat to declare bankruptcy, to waste spouses share of property, to refuse to see children, or to prevent spouse from obtaining legal counsel. ii. Lack of reasonable alternatives; and a. The test is subjective: whether the will of the person induced by the threat was overcome (rather than the will of a reasonably firm person). b. The victim must have no choice but to agree to the other partys terms or face serious financial hardship. 1. An available legal remedy, such as an action for breach of K, may provide an alternative. 2. The availability on the market for similar goods, services, or sources of funds to those withheld may also provide an alternative. 3. The victim may be required to tolerate a threat if it only involves a minor vexation. 4. An available alternative or remedy may not be adequate where the delay involved in pursuing the remedy would cause immediate and irreparable loss to ones economic or business interest. iii. Actual inducement of the K by threat.

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a. The improper threat must induce the making of the K; the threat must substantially contribute to the manifestation of assent. R2d 175 comment c. b. Earlier standards required the threat to be such as to overcome the will of a person of ordinary firmness and couragenow, the standard is subjective: whether the particular victim was induced by the threat. 1. Factors to consider: age, background, and relationship of the parties. 3. Undue Influence a. Undue influence is persuasion that tends to be coercive in nature and. b. Elements i. Pressure: a. Persuasion that tends to be coercive in nature; and 1. Hallmark of Such Persuasion = High Pressure a. Pressure that works on mental, moral, or emotional weakness. b. Excessive pressure by a dominant party upon an unduly susceptible servient party. i. Either a person of subnormal capacities is subjected to ordinary force or a person of normal capacities is subjected to extraordinary force. 2. Characteristics of Overpersuasion: a. Discussion of the transaction at an unusual or inappropriate time; b. Consummation of the transaction in an unusual place; c. Insistent demand that the business be finished at once; d. Extreme emphasis on untoward (adverse) consequences of delay; e. Use of multiple persuaders by the dominant party against a single servient party; or f. Statements that there is no time to consult financial advisers or attorneys. ii. Weakness: a. Overcoming anothers will without convincing his judgment: taking unfair advantage of anothers weakness of mind, necessities, or distress. 1. Weakness of mind need not be such as to totally or permanently incapacitate a party or leave him without the ability to understand. a. May be merely a lack of full vigor due to age, physical condition, exhaustion, or emotional anguish. iii. Confidential Relationship a. Original equitable doctrine of undue influence required the showing of a family or confidential relationship. 1. The presence of a special relationship will often be a significant factor in a courts finding of undue influence. 2. The mere fact that the parties have a close relationship, or that some influence is exerted, will not necessarily prove undue influence. b. A confidential or authoritative relationship between the parties need not be present when the undue influence involves unfair advantage taken of anothers weakness or distress. C. Misrepresentation and Nondisclosure

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1. Old C/L a. At law, fraud was not a defense to an action in assumpsit. i. Courts did allow recovery for damages from fraud in a separate action, which later became known as the tort of deceit and, in modern times, misrepresentation. b. In equity, courts allowed a party who had been a victim of fraud to avoid the K by way of equitable rescission (putting the parties back to the status quo before the K). i. Over time, law courts recognized a legal right to rescission; however, at law in order to obtain rescission, a party had to show that he had made a tender of any money or property received before instituting the action, while in equity, tender was unnecessary. 2. Modern C/L a. Under modern law, a victim of misrepresentation may have a choice between two significant avenues of redress: i. Tort action for damages; or ii. Avoid enforcement of K by way of rescission: a. As a defense; or b. In an affirmative action seeking restitution of benefits conferred to the other party. b. Choosing between Tort and Rescission i. Rescission requires the complaining party to return any money or property he has received. a. Rescission may be impossible if the complaining party is unable to return the property received from the wrongdoer because it has been transferred to a third party. ii. Rescission may be available for a material misrepresentation even if it were not made with fraudulent intent, which may be required for tort damages. R2d 164(1). 3. Fraud or Material Misrepresentation a. A K is voidable if a partys manifestation of assent is induced by either a fraudulent or a material misrepresentation by the other party upon which the recipient is justified in relying. R2d 164(1). b. Elements i. Misrepresentation; a. Conscious misrepresentation; b. Concealment; c. Non-disclosure of a material fact (see section below on Duty to Disclose); ii. Knowledge of falsity; a. A K may be subject to rescission (not tort) for innocent but material misrepresentation. R2d 162(2). b. A claim of misrepresentation may be based on a statement that is made recklessly or negligently. R2d 162(1)(b) and comment b. iii. Intent to induce reliance; iv. Justifiable, or reasonable, reliance; and v. Resulting damage.

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c. Fact v. Opinion i. Opinion is an expression of a belief, without certainty, as to the existence of a fact. Typically, opinions deal with matters such as quality and value of property. R2d 168(1). ii. Classical Rule a. Statement of opinion (or puffing) could not be fraudulent. iii. Modern Rule a. A statement of opinion amounts to a misrepresentation of fact if the person giving the opinion misrepresented his state of mind (i.e., stated that he held a certain opinion when in fact he did not). R2d 159 comment d. b. Normally, a statement of opinion amounts to an implied representation that the person giving the opinion does not know any facts that would make the opinion false and that the person giving the opinion knows sufficient facts to be able to render the opinion. R2d 168(2). c. A statement of opinion may be actionable if the one giving the opinion: 1. Stands in a relationship of trust or confidence to the recipient (a fiduciary relationship; 2. Is an expert on matters covered by the opinion; or 3. Renders the opinion to one who, because of age or other factors, is peculiarly susceptible to misrepresentation. R2d 169. d. Damages for Tort of Misrepresentation i. MIN: Out-of-Pocket Rule a. P may recover the difference between what he parted with and what he recovered, plus consequential damages that he suffered prior to the discovery of the fraud. ii. MAJ: Benefit-of-the-Bargain Rule a. P is to be put in the position that he would have been in if D had spoken truthfully. e. Communication with Party Represented by Counsel i. Under the Model Rules of Professional Conduct, it is improper for a lawyer to communicate about the subject of the representation with a party the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the consent of the other lawyer or is authorized by law to do so. 4. Integration Clauses / Releases of Liability / Disclaimers a. Any provision in a K making it possible for a party thereto to free himself from the consequences of his own fraud in procuring its execution is invalid and necessarily constitutes no defense. i. However, some courts hold that a party may not bring a tort fraud action where the agreement contains a specific disclaimer of representations (rather than a general or vague merger clause) because the clause shows a lack of justified reliance on any oral representations. ii. Some courts hold that disclaimers are effective for innocent or negligent misrepresentations but not intentional misrepresentations or material misrepresentations. b. Parol evidence is always admissible to show fraud, even if it has the effect of varying the terms of a writing between the parties. R2d 214(d).

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5. Duty to Disclose a. Classical Rule i. A party to a business transaction could not avoid the transaction because of nondisclosure of material information by the other party. b. Modern Rule - R2d 161 i. A failure to disclose a material fact may justify rescission of a K; a vendor has an affirmative duty to disclose material facts where: a. He knows that disclosure of the fact is necessary to prevent some previous assertion from being a misinterpretation or from being fraudulent or material; b. He knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which that party is making the K and if non-disclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing; 1. Factors a court should consider in deciding when fairness requires disclosure of material information: a. Difference in degree of intelligence of the parties; b. Relationship between the parties; c. Manner in which information is acquired (by chance, effort, illegal act some would say economics dictate requiring disclosure of information that was inexpensive to obtain but not requiring disclosure of information that was expensive to obtain); d. Nature of the fact not disclosed; e. Seller is more likely to be required to disclose information than the buyer; f. Nature of K (in releases and insurance Ks, practically all material facts must be disclosed); g. Importance of the fact not disclosed; and h. Conduct of the person not disclosing (e.g., active concealment). 2. When one conveys a false impression by the disclosure of some facts and the concealment of others, such concealment is in effect a false representation that what is disclosed is the whole truth. a. Some states require disclosure of material facts affecting the value of property known to one party but not reasonably capable of being known to the other. c. He knows that disclosure of the fact would correct a mistake of the other party as to the contents or effect of a writing, evidencing or embodying an agreement in whole or in part; or d. The other person is entitled to know the fact because of a relation of trust and confidence between them. 1. Where a fiduciary relationship exists, not only does a duty of disclosure apply, but the law also imposes additional obligations on the fiduciary: a. The terms of the transaction must be fair; and b. The terms must be fully explained to the other party. R2d 173.

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c. The fiduciary has the burden of proving compliance with his legal obligations by clear and convincing evidence. 2. A fiduciary relationship exists where one party reposes trust and confidence in another party who, in turn, accepts and fosters the relationship (e.g., attorney-client, trustee-beneficiary). ii. Innocent or Negligent Nondisclosure a. Several courts have indicated that a party who seeks rescission because of nondisclosure must show actual knowledge by the other party of the undisclosed fact. iii. Materiality = that to which a reasonable person would attach importance in determining his choice of action in the transaction. a. Some states impose a duty to disclose where a buyer makes an inquiry regardless of materiality. c. Due Diligence i. A party may reasonably expect the other to take normal steps to inform himself and to draw his own conclusions regarding facts of the transaction. R2d 161 comment d. d. Tort Liability for Failure to Disclose i. Nondisclosure will give rise to tort liability if the party is under a duty to the other to exercise reasonable care to disclose the matter in question. R2d Torts 551. a. The duty arises: 1. When there is a fiduciary or similar relationship; 2. When partial or earlier disclosures would be misleading; and 3. When the other party would reasonably expect disclosure of facts that are basic to the transaction. 6. Lawyers Professional Ethics a. If a lawyer violates fiduciary duties to a client, the lawyer may be subject to professional discipline as well as liability in either K or tort. b. Some courts hold that once an attorney-client relationship is established, there is a presumption (which may be overcome with clear and convincing evidence) of breach of fiduciary duty in dealing with the client. c. Rules of professional ethics impose restrictions on the conduct of lawyers in principally three areas: i. Lawyer-client relationship; a. Generally, these rules reflect the principles of loyalty, competence, and confidentiality. ii. Lawyers obligations to the system of justice; and iii. Permissible methods of obtaining business. D. Unconscionability 1. Historical Development of Ways to Deal with Unfairness In Ks a. Civil Law Systems i. Roman Law a. The doctrine of laesio enormis provided that a party could rescind a land sale transaction if the disproportion between the values exchanged was greater than two to one.

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ii. Modern Civil Law a. Germany and France recognize a number of doctrines that allow courts to refuse to enforce grossly unfair bargains. b. Old C/L i. In equity, a court could deny specific performance or other equitable relief if the price was inadequate or if the one seeking relief had unclean hands. ii. At law, a court could manipulate doctrines such as consideration, mutual assent, or principles of interpretation to find in favor of a party who was the victim of an unfair bargain. c. Reasons for Unconscionability Doctrine i. The Standard Form K a. The typical standard form K contains numerous boilerplate provisions that are extremely favorable to the drafting party. Negotiation of such terms rarely occurs because the other party does not read them or because the K is presented on a take-it-or-leave-it basis. b. The emergence of the standard form K brought into question the concept of mutual assent, a pillar of classical K law. ii. Awareness that poor and unsophisticated were potential victims for unscrupulous commercial parties. iii. UCC 2-302 codified the doctrine of unconscionability and has been incorporated into R2d 208; its principles have been applied to Ks other than just the sale of goods. 2. Unconscionability Doctrine a. A court may refuse to enforce a K which it finds unconscionable at the time it was made. UCC 2-302. i. Courts generally emphasize that Ks should not be judged in hindsight (subsequent performance may constitute breach of duty of good faith but has no bearing on unconscionability at time K was made). ii. The question of unconscionability is a question of law to be decided by the court but only after holding an evidentiary hearing. UCC 2-302. iii. Many courts have held that the doctrine of unconscionability is defensive and may not be used to obtain affirmative relief either by way of damages or restitution. a. A few courts, at least, have allowed damages or restitution after finding that the K or one of its clauses was unconscionable. b. A court may refuse to enforce just the unconscionable terms (where a claim for fraud generally voids the entire K). b. Unconscionability generally requires both (but see Sliding Scale below): i. Procedural Unconscionability / Absence of Meaningful Choice a. An absence of meaningful choice on the part of one of the parties. b. In many cases, the meaningfulness of choice is negated by a gross inequality of bargaining power (sometimes inequality of bargaining power can be inferred from a one-sided bargain). c. The manner in which the K was entered into is also relevant: 1. One partys lack of education or experience; 2. Opportunity to understand terms of the K;

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Fine print; Surprise; Deceptive sales tactics; Oppression due to inequality of bargaining power; Absence of real negotiation (K of adhesion / take-it-or-leave-it basis); or 8. Lack of counsel. ii. Substantive Unconscionability / Commercially Unreasonable Terms a. K terms which are unreasonably favorable to the other party; or b. Represent an overly harsh allocation of risks with no justification at the time of the agreement. c. The terms are to be considered in the light of the general background and commercial needs of the particular trade or case. UCC comments. d. Whether the terms are so extreme as to appear unconscionable according to the mores and business practices of the time and place. Corbin. e. Traditional Test 1. Terms that no man in his senses and not under delusion would make on the one hand and as no honest or fair man would accept on the other. 2. Terms that are so one-sided as to shock the conscience. f. Reasonableness Test 1. Some courts use a less stringent standard of reasonableness to determine whether terms are unconscionable. g. Price Terms 1. Excessive price may be a basis for unconscionability. R2d 208 comment c; UCCC 5.108(4)(c). 2. Courts normally do not assess the sufficiency of consideration, but if a court finds a gross inadequacy or failure of consideration, combined with other inequitable features, it will justify equitable rescission of the K. a. A number of early cases held consumer Ks unconscionable because of excessive price terms, and almost all involved an element of procedural unconscionability. 3. Courts have been divided in cases alleging unconscionable price terms, in part because of different views about how to determine when a price is excessive (going market price or the profit margin?). h. Limitation on Damages / Mandatory Arbitration / Confidentiality Clauses 1. If used solely for the benefit of one side and prevent the other party from achieving remedies (because, for example, they prohibit class actions or are financially prohibitive) they may be substantively unconscionable. Ting v. AT&T. 2. Unconscionability is one of the few ways to avoid a mandatory arbitration clause (fraud in the factum in formation of the K and fraud in the inducement of the specific arbitration provision are others. Rollins v. Foster.). i. Shortening Statute of Limitations Period

3. 4. 5. 6. 7.

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1. Generally not unconscionable if reasonable. c. Other Methods of Proving Unconscionability i. Sliding Scale a. Some courts allow less of one element if more of the other is present. b. Some courts suggest that an outrageous substantive provision may alone be enough for unconscionability. ii. Multifactor Balancing Approach (some courts and the Uniform Consumer Credit Code 5.108) a. Assessment of a number of elements including: 1. Whether the seller believes the consumer is likely to default on the obligation; 2. Whether the consumer will receive substantial benefit from the transaction; 3. Gross disparity between the K and market price; 4. Whether the seller has knowingly taken advantage of a consumers bargaining impairment due to mental impairment, lack of education, or lack of experience; 5. Use of a standard form K; 6. Limitations on available remedies for breach, 7. Use of inconspicuous or incomprehensible terms; 8. Overall imbalance in the bargain; and 9. Inequality in economic or bargaining power. 3. Consumer Protection Legislation a. Some critics say that the judicial process is an inefficient, often ineffective way of attacking contractual abuses. i. Legislatures rather than courts are said to be the appropriate institutions to examine the need for and scope of regulation. b. Consumer protection legislation has aimed at accomplishing three goals: i. Requiring commercial parties to disclose information to consumers in a meaningful fashion; ii. Substantive regulation where particular K provisions thought to be unfair are declared unlawful; and iii. Most consumer protection statutes contain provisions designed to improve enforcement. c. Truth-in-Lending Act (federal law) i. Primarily a disclosure statute, but also addresses enforcement, allows class actions and recovery of attorneys fees. d. Uniform Commercial Credit Code (only a few states have adopted) i. Primarily substantive regulation rather than disclosure; it sets maximum interest rates, prohibits assignment of wages or confession of judgment clauses. e. Magnuson-Moss Warranty Federal Trade Commission Improvement Act i. Dealt with consumer product warranties and increased the FTCs powers regarding unfair trade practices. f. State consumer protection laws

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i. Sometimes give P double or treble damages and award attorneys fees for willful violations of prohibited conduct. E. Public Policy 1. Although the process of K formation is untainted, a K may still be unenforceable because the K itself either violates or runs directly contrary to some public policy. a. Sometimes, this is referred to as illegality. b. Early courts refused to enforce Ks that involved usury or restraint of trade. c. Exceptions i. Courts recognize the strong public interest in freedom to contract and respect the ability of parties to bind themselves prospectively to future performance. ii. Courts will not necessarily deem void and completely unenforceable a K that is inconsistent with a statute or other basis of public policy. Rather, the courts may enforce the K or, more likely, may grant restitutionary relief to one of the parties. a. Courts may consider the nature of the public policy, degree of resulting forfeiture, unjust enrichment, and whether denial of relief would further the policy. R2d 178, 197. d. In Pari Delicto i. If both parties willfully engage in wrongful conduct (especially serious illegal conduct), and therefore are in pari delicto (in equal fault), courts usually take the position that the parties should be left where the court finds them and will give no remedy to either party, even if one has received a benefit from the other. 2. Valid and Identifiable Public Policy a. Employment At-Will i. In most jurisdictions, public policy may impose limits on the grounds that an employer may use to terminate an at-will employee, but that courts should be able to identify a valid source for the public policy. (see Good Faith above) b. Other Ks i. The same requirement that a court have a proper basis for public policy applies when the issue is whether a K should be enforced at all: courts should not refuse enforcement unless K is clearly contrary to public policy found in constitutions, statutes, or court decisions. 3. Ks that Conflict with Statutes a. When statutes declare that certain Ks are unenforceable or void, courts will obey the legislative mandate. R2d 178 comment a. b. More typically, the making of the K violates or is inconsistent with a statute, but the statute is silent on the question of whether the K is enforceable. i. Generally, violations of regulatory statutes, which are designed to protect the public, result in unenforceable Ks; ii. While violation of revenue-raising statutes will not generally prevent the enforceability of a K. 4. Ks between Spouses to Provide Services a. A marital duty to provide support, sympathy, comfort, love, companionship and affection to the other spouse under statute may require a spouse to provide nursing-type care to his or her ill spouse. Ks, therefore, in which a spouse is to

44

receive compensation for providing such services are void as against public policy and there is no consideration for the other spouses promise. Borelli v. Brusseau. i. Some would say that a marriage certificate should not deprive competent adults of the utmost freedom of K the would otherwise possess and that personally providing services to a spousesomething not required under the statutequalifies as valid consideration sufficient to make the ill spouses promise enforceable. 5. Ks Regarding Custody of a Child a. A K affecting the custody of a child in unenforceable on grounds of public policy unless it is consistent with the best interest of the child. R2d 191. i. This section is consistent with the view that termination of parental rights in exchange for money is against public policy, as commonly reflected in adoption statutes. b. Surrogate Parenting i. Because of policies underlying adoption legislation, surrogate-parenting agreements should be given no effect if the mothers agreement was obtained prior to a reasonable time after the childs birth or if her agreement was induced by the payment of money. The mother and father may not make a binding best-interests-of-the-child determination by private agreement. R.R. v. M.H. ii. MIN: A significant minority of states have statutes that address surrogacy agreements. a. Some simply deny enforcement of all such agreements. b. Others expressly deny enforcement only if the surrogate is to be compensated. c. Some states have simply exempted surrogacy agreements from provisions making it a crime to sell a baby d. A few states have explicitly made unpaid surrogacy agreements lawful. 1. Some states require the intended mother to be infertile. 2. Some states place restrictions on who may act as a surrogate and require advance judicial approval of the agreement. e. One state raises a presumption that a child born to a surrogate mother is the child of the intended parents and not the surrogate. iii. California has recognized that where both the sperm and the egg are donated to a gestational surrogate, the K would determine who the legal mother was. IV. Justification for Nonperformance A. General Resistance to Avoiding K Liability 1. Ks are frequently entered into for the purpose of protecting against various risks. K law, therefore, is generally resistant to the suggestion that contractual obligations might be avoided just because unforeseen or unprovided-for circumstances make it less favorable to one of the parties than had been originally contemplated. a. Nevertheless, there are a variety of legal doctrines that allow such an excuse from performance in appropriate cases. B. Mistake 1. General Rule Against Avoiding K because of Regret

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a. Ordinarily, the law will not permit one party to escape a contractual obligation merely because he later regrets the deal he made. i. Sometimes, however, the court finds that a more particular type of mistake, for which it allows an extraordinary type of relief. 2. Definition of Mistake a. A contractual mistake is an erroneous belief that is not in accord with the facts in existence at the time the K is executed. i. By definition, a mistake cannot be discovered until after the K is executed. ii. A mistake customarily involves such errors as the nature of the transaction, the identity of the parties, the identity of the things to which the K relates, or the occurrence of collateral happenings. 3. Mutual Mistake a. Traditional Rule i. Collateral (Value) Mistakes a. Mistakes regarding the quality or value of the property under K do not generally warrant rescission. ii. Mistakes Regarding Substance a. Mistakes regarding the very nature of the character or essence of the consideration generally warrant rescission. 1. For example, a barren cow is a substantially different animal than a breading cow. Sherwood v. Walker. b. Modern Rule i. Mutual Mistake as to a Basic Assumption a. Where a mistake of both parties at the time the K was made as to a basic assumption on which the K was made has a material effect on the agreed exchange of performances, the K is voidable by the adversely affected party unless he bears the risk of the mistake. R2d 152(1). ii. Material Effects on the Agreed Performance a. In determining whether the mistake has a material effect on the agreed exchange of performances, account is taken of any relief by way of reformation, restitution, or otherwise. R2d 152(2). iii. Assumption of Risk a. A party bears the risk of mistake when: 1. The risk is allocated to him by agreement of the parties; or 2. He is aware, at the time the K is made, that he has only limited knowledge with respect to the facts to which the mistake relates but treats his limited knowledge as sufficient; or 3. The risk is allocated to him by the court on the ground that it is reasonable in the circumstances to do so. R2d 154. b. An as is clause may indicate the parties intention to allocate the risk of mistake to the purchaser. 1. However, it may just serve as a disclaimer of warranties and not an indication to shift risks. a. UCC 2-316(3)(a) provides that an as is clause may effectively disclaim implied warranties in a sale of goods.

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b. However, UCC 1-103 says that the C/L doctrine of mistake is supplemented by the Code, not replaced by it. 2. Some courts will not allow an as is clause to relieve seller of liability for: a. Violation of environmental protection statutes; or b. Innocent misrepresentations by seller. 3. Some courts hold that because mutual mistake arises in situations beyond contemplation of the parties, all-purpose boilerplate as is clauses are ineffective because they lack adequate notice of what is being bargained for. iv. Discretion of the Court a. A court need not grant rescission in every case in which mutual mistake relates to a basic assumption and materially affects the agreed performanceit is an equitable remedy which is granted only in the sound discretion of the court. Lenawee County v. Messerly. v. Reformation / Scriveners Error a. When the mutual mistake consists of the failure of the written K to state accurately the actual agreement of the parties, reformation of the K to express the parties mutual intent is the normal remedy. vi. Remedies a. The relief available for other types of mutual mistake is ordinarily rescission, along with any restitution that may appear appropriate. b. As relief for mutual mistake is an equitable remedy, courts may exercise creative ingenuity in fashioning a remedy to fit the nature of the mistake. c. Since rescission for mutual mistake is not based on fault or misconduct of either party, the courts will consider whether the parties can be restored to the status quo ante, or its equivalent. d. Where the parties are both equally mistaken about the accuracy of the agreement (it contains a typographical error, or a provision has been mistakenly omitted), the remedy of reformation may be available. vii. Releases / Settlement Agreements a. Courts differ in the degree to which they will allow releases and settlement agreements to be set aside, for example when a party finds out that his injuries are worse that he thought they were at the time of settlement. b. Courts balance social policies of finality of litigation and fair compensation for injury. c. MAJ: Most courts apply a standard of whether the release was made fairly and knowingly. d. A claim of mistake as to the computation that formed the basis of a settlement or of the legal consequences of a settlement is likely to be characterized as a unilateral mistake and not considered a basis for relief. 4. Unilateral Mistake a. Traditional Rule i. Relief will not generally be granted if only one party to a K has made a mistake, unless mistake is material and so gross that the other party either

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b.

c.

d.

e.

knew or should have known that a mistake had been made. R 503 comment a, illustration 1. Modern Rule Wil-Freds v. Metropolitan Sanitary District i. The mistake must relate to a material feature of the K; ii. The mistake must have occurred notwithstanding the exercise of reasonable care; a. Many courts have held that the mistake must be non-negligent in order to be a basis for relief. b. But, there is a clear tendency to relax this requirement where the proof of mistake is strong and the effect of enforcement will be devastating or at least severely injurious to the mistaken party. c. Some states have interpreted statutes governing public contracting to preclude any relief for mistaken bidders. iii. The mistake must be of such grave consequence that enforcement of the K would be unconscionable; and iv. The other party can be placed in the status quo. Restatement Rule 153 i. Avoidance of a K for mistake of one party is allowed if: a. The mistake is such that enforcement of the K would be unconscionable (severe enough to cause substantial loss); or b. The other party either has reason to know of, or be responsible for causing, the mistake. ii. The Restatement expressly negates any requirement that the mistaken party be non-negligent, requiring only that its conduct not fall below the level of good faith and fair dealing. R2d 157. Mistake of Fact v. Mistake of Judgment i. Traditional Rule a. Generally, relief is refused for errors in judgment and allowed for clerical, mathematical, or other errors of fact. ii. Modern Rule a. More recent cases have been less disposed to insist on the rigidity of the fact-judgment distinction and more inclined to concentrate on the strength of the proof that a genuine and identifiable mistake was made (rather than merely a poor prediction as to how profitable the K would turn out to be). Duty to Read i. Can unilateral mistake provide an avenue for escape for a party who failed to read (or to understand) what he or she signed? a. Some courts would enforce the agreement in the absence of ambiguity, fraud, or mutual mistake. ii. Lawyer Errors a. Professional responsibility may require an attorney to inform the other side that they have prepared a writing that contains a scriveners error (even if it would be advantageous to the attorneys client). b. Most courts hold that a client should be bound to a disadvantageous agreement that its attorney, with greater diligence, might have or ought to have prevented.

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C. Change in Circumstances, Impracticability, and Frustration 1. These three doctrines usually involve changes in circumstances between the time of making the K and the time set for performance (although there are cases in which the circumstances in question already existed at the time of contracting, not to be discovered until later). a. R2d chapter 11 introductory note takes the position that defenses of mistake, impracticability and frustration of purpose should be questions of law rather than fact. Most courts view these as equitable remedies, thus, to be decided by the court rather than a jury. 2. Impossibility (Traditional Doctrine) R2d 262-64; UCC 2-613 a. Traditional Rule: Strict Liability i. K liability is historically a form of strict liability: nonperformance is actionable simply because D has failed to perform what he or she promised, not because that nonperformance is also culpable in any sense. b. Exception: Objective Impossibility (literal impossibility) i. When a person or thing necessary for performance of the agreement dies or is incapacitated, is destroyed or damaged, the duty of performance is accordingly excused. a. Casualty to Goods 1. The doctrine is easily applied to destruction of unique goods but more difficult for fungible goods (party will have to prove that the K called for the specific goods that were destroyed). b. Prohibition of performance by government action may excuse performance. R2d 264; UCC 2-615(a) and comment 10. ii. Apprehension of Impossibility a. Promisors decision not to perform must be an objectively reasonable response to an extraordinary, specific, and identifiable threat. Mere good faith will not excuse cancellation of performance. 3. Frustration of Purpose / Impracticability of Performance (Modern Doctrines) a. Frustration of Purpose R2d 265-66; UCC 2-615 i. Frustration of purpose is where the exchange called for by the K has lost all value to one party because of a supervening change in extrinsic circumstances (Krell v. Henry: The king canceled his coronation, so Ds K to use Ps room to view the parade was unenforceable because the K contained an implied condition that parade happen). a. There can be an overlap with mutual mistake (e.g., if the king had already canceled the coronation unbeknownst to the parties when they entered the K). b. The doctrine has been seldom applied in American courts. ii. Where after a K is made, a partys principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the K was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary. R2d 265. a. Three Factors (Karl Wendt v. Intl. Harvester):

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1. The purpose frustrated by the supervening event must have been the principal purpose of the party making the K. a. The object must be so completely the basis of the K that, as both parties understand, without it the transaction would make little sense. b. The frustrating event must not occur because of the fault of the party seeking discharge. c. Economic return may be considered the principal purpose of every commercial K, but mere economic impracticability is no defense to performance of a K. 2. The frustration must be substantial. a. It is not enough that the transaction become less profitable for the affected party or even that will sustain a loss. The frustration must be so severe that it is not fairly to be regarded as within the risks that he assumed under the K. R2d 265 comment a. b. The fact that performance has become economically burdensome or unattractive is not sufficient to excuse performance. R2d 265 comment a. 3. The frustrating event must have been a basic assumption of the K. b. Impracticability R2d 261, 266; UCC 2-615, 2-616 i. Performance may be excused even though it is not literally impossible or even subjectively impossible but sufficiently different from what the parties had both contemplated at the time of contracting. ii. Where, after a K is made, a partys performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the K was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary. R2d 261. iii. Change in Market Conditions a. Most courts refuse to grant relief under the doctrine to a party who seeks to avoid a K that has become more expensive or less profitable due to change in market conditions. R2d 261 comment d. 1. However, a severe shortage of raw materials or of supplies due to war, embargo, local crop failure, unforeseen shutdown of major sources of supply, or the like, which either causes a marked increase in cost or prevents performance altogether may bring the case within the rule of impracticability. R2d 261 comment d b. The continuation of existing market conditions and of the financial situation of one of the parties are ordinarily not basic assumptions upon which the K was formed. R2d 261 comment b; Karl Wendt v. Intl. Harvester. c. Frustration and Impracticability both require the disadvantaged party to show: i. Substantial reduction of the value of the K; ii. Because of the occurrence of an event, the nonoccurrence of which was a basic assumption of the K; iii. Without the partys fault; and

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d.

e.

f.

g.

h.

iv. The party seeking relief does not bear the risk of that occurrence of the event either under the language of the K or the surrounding circumstances. v. Differences between Frustration and Impracticability Kuhn Farm Machinery a. Impracticability of performance is utilized when certain events occurring after a K is made constitute and impediment to performance by either party. The Restatement no longer uses impossibility; instead it substitutes the term impracticability. b. Frustration of purpose deals with the problem that arises when a change in circumstances makes one partys performance virtually worthless to the other. 1. Performance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event, which supervenes to cause an actual but not literal failure of consideration. 2. Frustration of purpose, unlike impracticability, involves no true failure of performance by either party. Change in Market Conditions i. Most courts refuse to grant relief under either doctrine to a party who seeks to avoid a K that has become more expensive or less profitable due to change in market conditions. Natural Disaster and War i. Courts are generally unwilling to grant relief when natural disaster or war are the basis for claimed relief under the doctrines of impracticability and frustration. Physical Impossibility i. If a particular person or thing is necessary for performance, the death or incapacity of the person, or the destruction of the thing, will excuse performance on the ground of impracticability. a. Death or incapacity of person R2d 262 b. Destruction of a thing R2d 263 c. Casualty to identified goods UCC 2-613 ii. However, the excuse may not be available if the parties provided for the event in their agreement. Foreseeability i. MIN: Some courts require a showing that the event complained of was at least unforeseenperhaps even unforeseeableat the time the parties made their K (many courts feel that a party who can foresee an adverse event has the burden of contracting for protection against it). ii. MAJ: Most courts hold that relief under the doctrines of impracticability or frustration of purpose should not be denied simply because the event may have been foreseeable (foreseeability or even recognition of an event does not prove its allocation). iii. UCC: 2-615 does not expressly impose any unforeseeability requirement. The commentators agree that foreseeability of an event should not prevent relief. Overall Operations of the Party

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i. Some courts have considered whether the event for which relief is sought affected not just the K in question but the companys entire operations. i. Economic Analysis of Risk Burden i. When the K specifically allocates the risk to a party, that party is the superior risk bearer. In the absence of a K provision, the risk should be assigned to the party who is in the best position to prevent the event from occurring, or if prevention is not possible, to minimize its consequences at the lowest cost, typically by purchasing insurance. j. Crop Failure i. Economic analysis may indicate that the purchaser of crops is in the best position to bear the risk of loss because he can enter into Ks with many suppliers. ii. Some courts will not excuse producers of crops in cases of crop destruction, though, unless the K specifically identifies the land on which the crops were to be produced. iii. UCC 2-615 comment 9 suggests that crop failure may be regarded as excusing either under that section or 2-613 where a farmer has contracted to sell crops to be grown on designated land. D. Modification 1. C/L Pre-Existing Duty Rule R2d 73 a. When a party merely does what he has already obligated himself to do, he cannot demand an additional compensation even if he has taken advantage of the other partys necessities and exacted a promise for more compensation. The modification is presumptively unenforceable absent an exception to the rule. i. A party who refuses to perform, and thereby coerces a promise from the other party to the K to pay him an increased compensation for doing that which he is legally bound to do, takes an unjustifiable advantage of the necessities of the other party. ii. Consent to such a demand is without consideration becausebarring waiver by the other partyit is based solely upon the agreement to render the exact services that the party was already under K to render. b. Exceptions: i. Unanticipated Difficulties Rule R2d 89(a) a. Where the party refusing to complete his K does so by reason of some unforeseen and substantial difficulties, which were not known or anticipated by the parties when they entered the K, and which cast upon him a burden not contemplated by the parties, and the other party promises him extra pay or benefits if he will complete his K, the promise to pay is supported by a valid consideration. 1. Unforeseen difficulties may provide additional consideration even if they do not rise to a defense for impracticability or frustration of purpose. ii. Surrender of Defense R2d 74 a. Surrender of a defense, even if invalid, may be consideration if the defense was doubtful because of uncertainty as to facts or law. iii. Detrimental Reliance R2d 89(c)

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a. The modification may induce a material change of position so that injustice will result if enforcement is not forthcoming. 1. In light of the apparent intention of 89 to liberalize the consideration requirement for modifying agreements, performing as originally promised might constitute reliance that satisfies the requirement of 89(c). a. This produces a paradoxical result: performance already promised would not constitute consideration under 73 but would, under 89(c), be sufficient detrimental reliance to require enforcement. iv. Surrender of a Better Offer a. Many courts will enforce a promise by to pay more money for previously agreed upon performance if one party informs the other party that he has a better offer from someone else. 1. Some courts view a superseding, inconsistent agreement covering the same subject matter as a mutual rescission followed by a new and valid K, which operates as a waiver of any claim for breach of the earlier K not expressly reserved, unless the superseding K was executed under duress. 2. Other courts might enforce the new K because there is no coercion on the part of the employee, the circumstances had changed unexpectedly, or the employee had justifiably relied on the promise of the pay raise. c. Employment Agreements i. Several courts have held that an attempt by an employer to change the terms of employment unilaterally by promulgating a new employee handbook are ineffective because unsupported by any consideration. a. Some courts allow modification stating that the issue is not one of K formation but employment policy. ii. Some courts will likewise refuse to enforce a promise by an employer of greater benefits for an employees performing duties he is already required to perform. a. However, if the employee performs more than his required duties, he may provide consideration for the increased benefits. iii. Three Approaches to Modification of Employment-at-Will Ks: a. A subsequent modification may be considered an offer, which the employee accepts by continuing his or her employment with the employer. b. In order for a subsequent modification to be effective, it must be sufficiently communicated to the employee. c. In order for a subsequent modification to be effective, there must be mutual assent and additional consideration. d. C/L NOM Clauses i. At C/L, a no-oral-modifications clause (NOM clause) was usually held to be ineffective to restrict the parties freedom to later modify their agreement by whatever mode they might choose, written or oral. e. Accord and Satisfaction i. Pre-UCC law held that so long as the amount owed one party was either unliquidated (no reduced to a dollar amount) or the subject of good faith

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dispute, acceptance of a check tendered in full payment will in legal effect amount to an accord and satisfaction that discharges any remaining obligation. a. Agreements to settle a liquidated, undisputed claim for less than the full amount have traditionally not been binding on the creditor. Foakes v. Beer. b. Under traditional and modern C/L, an attempt at endorsing a check offered in full payment of a debt under protest or with full reservation of rights would have no effect; the cashing of the check would still amount to acceptance by the creditor of the debtors offer of an accord and satisfaction. 2. UCC Modification Rules a. No Consideration Needed i. Modification of agreements under Article 2 are not subject to the C/L requirement of consideration. Modifications will generally be enforced except in special circumstances. UCC 2-209(1). a. There are no formal requirements for modifications under 2-209 such as the writing requirement for firm offers under 2-205. b. Good Faith i. An obligation of good faith acts as a bar to extortion of a modifying agreement without legitimate commercial reason. UCC 2-209(1) comment 2. a. A party may in good faith seek a modification when unforeseen economic exigencies exist which would prompt an ordinary merchant to seek a modification in order to avoid a loss on the K. b. Even where circumstances do justify asking for a modification, it is nevertheless bad faith conduct to attempt to coerce one by threatening breach. 1. The inference of bad faith arising when a breach is threatened may be rebutted by a showing that the party threatening not to perform did honestly believe that it had a legal defense to the duty of performance. a. This legal justification for nonperformance should be offered at the time modification was sought, not as an afterthought in litigation (otherwise there would be a lack of honesty in fact that good faith requires). ii. Duress a. Where K modification is at issue, the law of duress and the law of good faith will tend to merge, as courts focus on the issue of coercion as the principal basis for resisting modification enforcement. iii. Resisting Modification a. Some courts have held that the party agreeing to an assertedly coerced modification has a good faith duty to make plain that it is acting under protest, so that the other party will not be deceived as to its intention eventually to resist enforcement or seek redress. c. Statute of Frauds and Modification i. General Rules

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a. Requirements of the SOF must be satisfied if the K as modified is within its provisions. UCC 2-209(3). 1. MAJ: Most courts have held that a modification must be in writing not only when the modification brings an oral K within the SOF but also even when the original K was in writing. 2. MIN: Some say that an oral modification of a written agreement would be enforceable unless the modification would change the quantity term or increase the price above the $500 UCC threshold. b. Private SOF / NOM Clause 1. Signed Ks that exclude modifications not in the form of a signed writing are generally valid (no-oral-modification, or NOM clauses) even if SOF does not apply. UCC 2-209(2). 2. Between a consumer and a merchant, a NOM clause must be separately signed if included in a form supplied by the merchant. UCC 2-209(2). 3. The parties may in effect make their own private SOF regarding any future modification of the K by giving effect to such a clause. UCC 2-209 comment 3. a. The rules governing the SOF would also apply to a private SOF. ii. Exceptions a. Immaterial Changes 1. If the oral changes do not materially alter the underlying obligations, for example, they are not barred. b. Promissory Estoppel 1. Promissory estoppel in some cases forbids reliance on the SOF as a defense to the validity of oral agreements. a. Where one party reasonably relies on the oral promise of another to reduce an oral agreement to writing, the failure to create such a writing will not prevent the relying party from taking the modification out of the SOF. R2d 178 comment f. i. A promise to make one written modification may imply that the party would make additional written modifications as necessary to allow the parties commercial dealings to go forward. Brookside Farms v. Mama Rizzos. ii. Inducing reliance by promise or an extended course of action and then breaking that promise may be a violation of the C/L or UCC duty of good faith. c. Goods Accepted and Received or Payment Made 1. A K which does not satisfy the general SOF, but which is valid in other respects, is enforceable with respect to goods for which payment has been made and accepted or which have been received and accepted. UCC 2-201(3)(c). a. An oral modification that would itself form a binding K in the absence of SOF considerations can be binding on the parties to a sale of goods over $500 insofar as specific goods have been received or paid for and accepted.

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b. Only Applicable to Goods Accepted i. Modification for the future cannot be conjured up by oral testimony if the price involved is $500 or more since such modification must be shown at least by an authenticated memo, which is limited in its effect to the quantity of goods set forth in it. UCC 2-209 comment 3. d. Waiver by Actual Later Conduct 1. NOM clauses do not limit the actual later conduct of the parties; such later conduct may act as a waiver of contract obligations or the NOM clause. UCC 2-209 comment 4. e. Waiver by Attempted Modification 1. Although an attempt at modification or rescission does not satisfy the requirements of the SOF or a NOM clause, it can operate as a waiver if one party detrimentally relies on the assurances of the other party. UCC 2-209(4). a. Whether reliance is a necessary ingredient of the waiver claim or not, the cases do generally support the proposition that the NOM clause may be waived, by oral agreement to that effect, or by some combination of words and conduct that in the circumstances evidences the parties willingness to dispense with its protections. i. A clause in a K that requires amendments to be in writing may itself be waived. Where one party detrimentally relies on an oral modification, the other party is prevented from invoking the clause. CBS v. Merrick. f. No-Waiver Clauses 1. No-waiver clauses may be overcome in the same manner that the SOF may be overcome, by actual performance, although 2-209 does not expressly provide so. Brookside Farms v. Mama Rizzos. 2. If a NOM clause may in the proper circumstances be deemed to have been orally waived, the presumably a no-waiver clause could be, too. 3. NOM and no-waiver clauses may be overcome similar to ways a merger clause may be overcome. g. Accord and Satisfaction 1. Claim arising out of breach can be discharged in whole or party by written waiver or renunciation, without consideration. UCC 1-107. 2. Cashing a full payment check even with a reservation of rights (endorsed under protest or with full reservation of rights) constitutes an accord and satisfaction, barring the creditor from collecting the unpaid balance, unless the creditor can establish a ground for avoiding the accord and satisfaction, such as duress. V. Rights and Duties of Third Parties A. Rights of Third Parties as K Beneficiaries 1. When two parties form a K, they do not ordinarily have the power under law to affect adversely any right of a person who is not a party to their K. a. The power to invade and destroy the rights of nonconsenting persons can only be conferred by public law.

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b. Private law, i.e., the kind of legally enforceable obligations that result from the making of a private agreement, generally cannot destroy or impair the rights of anyone who is not a party to that agreement; nor can it impose duties on such a person. 2. The parties may create a K right in some person, though. a. Third-Party Beneficiaries i. Early C/L a. Creditor (Obligee) Beneficiaries 1. MAJ: A creditor beneficiary may enforce a promise made between two other parties if it is to his benefit and the promisee is indebted to the creditor and the promised performance will discharge that obligation. R2d 302(1)(a) a. If A loans money to B, and B loans the same amount of money to C, and C promises B that he will repay A, A can sue C for breaking his promise to B even though he lacks privity with C. Lawrence v. Fox. b. As right to sue C is similar to a beneficiarys right to sue a trustee who breaks his promise to a trust settlor. c. The plaintiff is referred to as a third-party beneficiary, creditor beneficiary, or obligee beneficiary of defendants promise. b. Donee Beneficiaries 1. Although early decisions only applied the third-party beneficiary doctrine to creditor-beneficiary cases, later decisions extended recovery to cases where the promisee had apparently sought to confer benefit of the promisors performance as a gift to a child, parent, or some other member of the promisees family. R2d 302(1)(b) a. P is referred to as a donee beneficiary. ii. Modern C/L a. Intended / Incidental Beneficiaries 1. The principle that a third party may have standing to recover on a K is now universally accepted in American courts. R2d 302, 304. 2. The distinction between creditor and donee beneficiaries is not as important as between intended beneficiaries (who enjoy a right of direct action) and incidental beneficiaries (who do not). a. However, R2d keeps slightly altered variations of the old creditor/donee beneficiary definitions in 302(1)(a) and (b). b. Standing of Third Parties i. Intent of Parties (3 rules) a. Traditional Rule 1. The intent of both parties (rather than just the promisee) to a K determines whether a third party has contract rights as a beneficiary. Grigerik v. Sharpe. a. Each party to a K is entitled to know the scope of his or her obligations thereunder; this includes the range of potential third persons who may enforce the terms of the K. b. Promisee-Intent Rule

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1. The promisees intent alone determines third-party beneficiary standing. c. Modern Rule 1. The promisor must know or have reason to know of the promisees intent to benefit the third party, even if the promisor has no particular desire to confer a benefit on or create an obligation to the third person. d. Evidence of Intent 1. The K may expressly confirm or deny standing for third-party beneficiaries. 2. Some courts apply a presumption against third party standing that will be overcome only by clear and convincing evidence to the contrary found in the K. a. Recent cases indicate that in the absence of a clear K provision, a totality of the circumstances approach will often be used (language and provisions of the agreement, background of the K, fairness, and practicality). 3. Incidental and foreseeable beneficiaries are not necessarily intended beneficiaries. ii. Performance a. Ks for the benefit of a third party are enforceable without any requirement that the promisors performance be rendered directly to the intended beneficiary. b. Drafting a Will 1. MAJ: A party who was intended to receive a bequest under a will may sue the drafting attorney for errors that defeat the intended bequest in K, tort, or both. a. Difference between K or tort cause of action: SOL, comparative fault rules, and remedies. 2. MIN: Not all jurisdictions have recognized standing for intended beneficiaries to sue for breach of a K to draft a will. a. However, even without privity, attorneys who engage in fraud can be held liable to third parties. c. Standard of Conduct 1. Whether in tort or K, the standard of conduct (or implied promise to exercise care) for a professional is the degree of skill and care customarily exercised by members of that profession. c. Defenses of Promisor i. All of the rules of K formation apply as well as defenses related to fraud, duress, mistake, etc. when a third-party beneficiary attempts to enforce a promise against a promisor. R2d 309. ii. An arbitration clause or similar K provision also may be enforceable against a third-party beneficiary. iii. However, if the promisor undertakes an unqualified obligation to render a performance to the third party beneficiary, then the promisor will not be able to use a defense against the beneficiary that might have been asserted by the promisee.

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d. Vesting of Third-Party Rights i. Old C/L Rules (some courts may still follow) a. Donee beneficiary vest immediately. b. Creditor beneficiary vest upon reliance. ii. Modern C/L Rules a. Unless the K prohibits modification by the promisor and promisee, R2d 311 permits variation of the rights of the intended beneficiaries until the third party does one of three things: 1. Manifests assent at the invitation of the promisor or promisee; 2. Materially changes position in justifiable reliance on the promise; or 3. Brings suit on the promise. iii. Minor Beneficiaries a. Because minors lack capacity to contract, the court may presume the assent of a minor beneficiary but may also enforce the parties express reservation of rights to modify the agreement. e. Standing of Promisee i. The promisee may have standing to enforce the K if the promisor fails to perform for the benefit of the third party. However, the proper remedy may be specific performance or nominal damages in light of the promisees limited economic interest in performance. R2d 305, 307. 3. Contracting with Governmental Entities a. Duty to Class of Intended Beneficiaries i. Once it is established that a K exists between a promisor and the government, the class intended to be benefited or protected by the K are third-party beneficiaries of the K. Zigas v. Superior Court; R2d 313(1). a. The intended class should be limited and specific, not the public at large, which could expose the promisor to unlimited liability. b. The promisor may also be liable for restitution to the intended beneficiaries if it retains the benefit of the governments performance but does not fulfill its promise. c. SPLIT: Some courts hold that beneficiaries of regulatory agreements with the government (such as the low-income housing tenants in Zigas who sued their landlord to enforce its promise to the government to only charge HUD-approved rents) are incidental beneficiaries without standing to sue while some courts hold that they are intended beneficiaries with standing. b. No Liability for Consequential Damages for Breach of K Benefiting the Public (Incidental Beneficiaries) i. A promisor who contracts with the government to do an act for the public is not subject to contractual liability to a member of the public for consequential damages resulting from performance or failure to perform unless: a. The terms of the promise provide for such liability; or b. The promisee is subject to liability to the member of the public for the damages and a direct action against the promisor is consistent with the terms of the K and with the policy of the law authorizing the K and prescribing remedies for its breach. R2d 313(2).

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ii. SPLIT: Some courts do not follow this rule and allow recovery for consequential damages suffered by members of the public for a breach of promisors K with the government. B. Assignment and Delegation of K Rights and Duties 1. Today in every American jurisdiction, it is generally trueeither by statute or court decision, or boththat the assignee of a K right may bring suit to enforce the assigned right, without regard to distinctions between law and equity. a. Statute or rules of court usually permitindeed, usually requirethat such a suit be brought in the name of the real party in interest, the assignee. 2. Assignment a. A K right (i.e., the ability to require the other party either to perform or to pay damages) can today be assigned. R2d 317(2). i. An assignment is an act or manifestation by the owner of a right (the assignor) indicating his intention to transfer that right to another person (the assignee). a. The assignment must manifest a present transfer of rights. 1. A promise to make an assignment in the future may be enforceable against the promisor but does not constitute an effective assignment that would affect rights or duties of the other party to the K. R2d 330. b. No magic words are required to make an assignment, and it may be made orally. R2d 324. ii. Such an assignment at once creates in the assignee a new right, which at the same time extinguishing the corresponding right previously held by the assignor. R2d 317(1). b. Restrictions on Assignment i. A K right may be assigned unless the assignment would have a material adverse effect on the other party to the original K (the obligor): a. Materially change the duty of the obligor; b. Materially increase the burden or risk imposed upon the obligor by his K; c. Materially impair the obligors chance of obtaining return performance; d. Materially reduce the value of the return performance to the obligor; or 1. In light of the public policy in favor of assignability, courts will generally be reluctant to find that the assignment would have a material adverse effect on the obligor. ii. Violate a statute, public policy, or valid K term. R2d 317(2); UCC 2210(2). a. Statutes 1. Almost every state has some form of statutory restriction on assignment of wages. Federal statutes restrict assignment of any public K or order and any claim against the government. b. Gratuitous Assignments 1. A gratuitous assignment generally remains revocable unless formal requirements for a valid gift are met. R2d 332. c. Tort Judgments 1. Courts have often held that parties may assign the proceeds of a tort judgment but not the prejudgment tort claim itself (to prevent people

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from purchasing causes of action and trafficking in lawsuits for pain and suffering). d. Future Rights 1. Courts have also traditionally been reluctant to enforce assignments of future rights because of a public policy which seeks to protect the assignor and third parties against transfers which may be improvident or fraudulent. R2d 321 comment b. a. R2d 321(1) makes an exception to this prohibition: Except as otherwise provided by statute, an assignment of a right to payment expected to arise out of an existing employment or other continuing business relationship is effective in the same way as an assignment of an existing right. e. Personal Services K 1. Although state law may prohibit assignment of personal services Ks, a court may enjoin a party from performing services for anyone else for the duration of the K if his performance for the assignee is the same as it would be for the assignor (e.g., assignment of basketball players K to a new team owner enforced notwithstanding the prohibition on assignment). Munchak v. Cunningham. 2. Non-Compete Agreements a. Personal services or employment Ks often involve express covenants not to compete after termination. b. SPLIT: Courts are divided on whether an employer may assign the rights to such a covenant to a successor that buys the business and for which the employee often continues to work for some period of time. f. Requirements Ks 1. Some early cases held that the typical requirements K was not assignable because of the sellers substantial interest in the particular circumstances and creditworthiness of the buyer. a. UCC 2-210 comment 4 suggests strongly that the application of 2-306 and 2-609 should ordinarily overcome this objection, unless material personal discretion is involved. c. Partial Assignment i. Traditional C/L Rule: Some courts deny enforcement to partial assignment of rights made without the obligors consent (because of concerns about the inconvenience to the obligor of splitting its performance and the exposure of the obligor to multiple lawsuits). a. Traditional Equity Rule: Partial assignments were traditionally enforceable in equity courts, though. ii. Modern Rule: Many courts will enforce partial assignments in the same manner as a full transfer (because of modern procedural and joinder rules). R2d 326. a. The possibility still remains that the splitting of rights into too many partial assignments would impose a material adverse burden on the obligor, though.

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d. Assignable K Rights notwithstanding K Provisions to the Contrary i. Payment of Money a. In some cases, the right to payment of money can always be assigned even though the K may attempt to prohibit such a transfer. UCC 2-210(2), 9318(4). 1. This right to assign is limited to cases in which the seller has earned payment by full performance or the K has been discharged by breach of the whole K. UCC 2-210(2). ii. Non-assignment Clauses a. While K terms may preclude assignment, R2d 317(2), a no assignment clause will first be construed only to prohibit delegation of duties, and alternatively, will be read to constitute a promise not to assign rights that might lead to damages for breach but will not render the assignment ineffective. R2d 322. 1. The R2d 322 preference for interpreting a non-assignment clause would be applied unless a different intention is manifested; this suggests that some language might be strong enough to actually prohibit assignment of rights. 2. SPLIT: A number of courts have taken a position consistent with R2d 322 and limited the effectiveness of non-assignment clauses (unless they have strong language like shall be void or invalid) but many courts routinely enforce terms prohibiting assignment (although narrowly). e. Notice to Obligor i. Once an obligor receives notice of an effective assignment of rights, performance must be rendered to the assignee; payment to the assignor will not defeat the assignees rights. f. Defenses Against an Assignee i. An assignees right against the obligor is subject to any defense or claim arising from his conduct or to which he was subject as a party or a prior assignee because he had notice. R2d 336(4). g. Assignment of a Receivable i. For an assignment to be valid and enforceable against the assignors debtor (the obligor), the assignor must make clear his intent to relinquish the right to the assignee and must not retain any control over the right assigned or any power of revocation. a. Once the obligor has notice of the assignment, he thereafter holds the amount owed in trust for the assignee. After receiving notice of the assignment, the obligor cannot lawfully pay the amount assigned either to the assignor or to his creditorsonly to the assignee. 1. Even an attorney (who may have an ethical obligation to promptly pay or deliver funds to a client, as the client requests) must honor a valid assignment in disbursing the funds. Herzog v. Irace. 3. Delegation

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a. In many cases, a person who is subject to a duty of performance may properly delegate that duty, that is, may satisfy it by employing others to perform it for him. R2d 318(1); UCC 2-210(1). i. Generally, an assignment will include both assignment of rights and delegation of duties unless the circumstances dictate otherwise. R2d 328; UCC 2-210(4). b. Personal Services K i. Where a K imposes on an individual the duty of personal service (e.g., artists, physicians, lawyers, and possibly architects, depending on parties intent), that duty is almost always regarded as inherently non-delegable, unless the other party assents. R2d 318. c. Unsatisfactory Delegate to a Sale of Goods K i. UCC allows delegation except where delegated performance would be unsatisfactory to the obligee: a party may perform his duty through a delegate unless otherwise agreed or unless the other party has a substantial interest in having his original promisor perform or control the acts required by the K. UCC 2-210(1). a. Policies of free alienability of commercial Ks are balanced against protecting the obligee from having to accept a bargain he did not contract for. 1. The question is not whether the delegate would perform as good a job as the obligor but whether the obligee has a substantial interest in having his original obligor perform or control the acts required by the K. ii. Delegation to a Direct Competitor a. The duty of performance under an exclusive distributorship may not be delegated to a competitor in the marketplaceor the wholly owned subsidiary of a competitorwithout the obligees consent. Sally Beauty v. Nexxus. 1. An exclusive distributorship entails an obligation to use best efforts; it is reasonable for a party to conclude that its direct competitors performing this obligation is different from what it bargained for. d. Non-Delegation Clauses i. Unlike non-assignment clauses, courts are generally likely to enforce a clause prohibiting delegation of a duty. R2d 322(1); UCC 2-210(5). ii. Landlord / Franchisor Consent a. Courts are divided on whether to allow a landlord or franchisor to arbitrarily refuse to approve assignment when the K expressly requires their consent. 1. Some courts impose a standard of reasonableness in the decision to approve an assignment unless the K expressly allows the landlord / franchisor unfettered discretion. 2. Other courts take the opposite view that a K requiring consent to assignment grants an unrestricted right to withhold approval as long as the lessor / franchisor acts honestly. e. Original Obligor Still Liable

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i. The person originally bound to perform will remain subject to that duty until performance is actually rendered. R2d 318(3); UCC 2-210(1). ii. Release a. If the obligee consents to the delegation and agrees to release the original obligor, the substitution of the delegate produces a novation and creates a new duty owed to the obligee, but evidence of the novation must be clear. R2d 280, 318 comment d. 1. Even in the absence of a novation, the obligee would have standing to bring a suit directly against the delegate as an intended beneficiary of the agreement by which the delegate promises to assume the original obligors duty. 4. Defenses and Rights of the Parties a. If an assignment is effective, with respect to the original K, the assignee stands in the shoes of the assignor. i. Obligors Claims and Defenses a. The assignee will be subject to any claims or defenses that the obligor has that arise out of the K assigned. UCC 2-210(4); 9-318(1)(a). b. The rights of the assignee under the K assigned will also be subject to claims and defenses of the obligor arising from other Ks than the one assigned (that the obligor may have entered into at other times with the assignor), but only as to claims or defenses that accrue before the obligor receives notification of the assignment. R2d 336(2); UCC 9318(1)(b). c. The assignee may, however, be protected from the obligors claims or defenses if the obligor has signed an enforceable waiver of claims and defenses or if the assignee is a holder in due course of a negotiable instrument. UCC 9-206, 3-302. ii. Assignees Damage Liability a. When an assignment includes a delegation of duties, the obligor can not only assert the defenses against the assignees attempt to enforce the assigned right, he can affirmatively assert damage liability against the assignee for nonperformance of the assignors obligations under the original K, even if that liability should exceed the amount of the right assigned. iii. Arbitration Agreement a. The assignee will likely be bound by an arbitration clause in the original K. 1. A number of courts have rejected the argument that arbitration agreements are personal and non-assignable because of their inherent waiver of constitutional and procedural rights. VI. Consequences of Nonperformance A. Breach of K 1. Definition of Breach a. When performance of a duty under a K is due, any nonperformance is a breach. R2d 235(2).

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i. Performance is not due if nonperformance is justified for any reason. R2d 235(2) comment b. 2. Conditions a. Dependent Promises = Conditions i. The duty of performance will not ariseabsent excuse of the condition unless and until the conditioning event occurs. One partys performance is dependent on some performance by the other party. b. Three Types of Conditions R2d 226 comments a, b. i. Express conditions ii. Implied-in-fact conditions (inferred from the conduct of the parties) iii. Constructive conditions (created by a court for reasons of justice; there may be little difference between implied-in-fact and constructive conditions) a. Unlike express conditions, which result from the agreement of the parties, constructive conditions are judicially created devises to determine the consequences of breach when the parties have failed to so specify in their agreement. c. Order of Performance (unless expressly agreed otherwise) R2d 234 i. Performances that can be rendered at the same time are due simultaneously. a. Ks for the conveyance of land or for the sale of goods are viewed by the law as being capable of simultaneous performance; absent agreement otherwise, they will be construed as calling for simultaneous rendition of performances (to sue for breach, the party must show that he at least tendered performance). UCC 2-507, 2-511. ii. If performances cannot be rendered at the same time, the performance requiring the longer period of time must be rendered before the performance requiring the shorter period of time will be due. a. Construction Ks and employment Ks are ordinarily construed as requiring performance of the work to be completed before payment is due. d. Partial Performance i. Early C/L: Full rendition of the entire performance contracted for was a condition precedent to the right to recover any of the promised compensation. ii. Some courts: Allow for recovery on a claim for quantum meruit (restitution). iii. Some courts: Allow for recovery on the K under the doctrine of substantial performance by a party whose breach is not material. 3. Substantial Performance a. Each partys duty of performance is implicitly conditioned on there being no uncured material failure of performance by the other party. R2d 237. i. Minor or immaterial deviations from the K provisions do not amount to failure of a condition on the other partys duty to perform. a. Whether performance is substantial is a question of fact that considers the magnitude of the defects, whether the party can use the product for its intended purpose, and timeliness of the performance. ii. Minor deviations will give the other party a right to recover damages for that nonperformance. a. In most cases of defective performance, the cost of repair, replacement, or completion is the measure of damages.

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b. If the cost of completion is grossly and unfairly out of proportion to the good to be attained, the measure of damages is the difference in value between what was promised and what was performed. Jacobs & Young. b. Willful Transgressor (SPLIT) i. Corbin/R2d: A willful breach does not automatically bar recovery, but the motive of the breaching party is a factor to be considered in determining whether performance was substantial. R2d 241(3) and comment f. ii. Jacobs & Young: A willful transgressor will not be entitled to recover under the substantial performance doctrine. c. Divisible K i. Where a K consists of several and distinct items to be furnished or performed by one party, a court may find the K divisible. This means that the overall K can be divided into a number of part performances and a portion of the K price allocated to each part performance. ii. Two requirements: R2d 240. a. It must be possible to apportion the performances of the parties into corresponding pairs of part performances; and b. It must be proper to treat these pairs of part performances as agreed equivalents. 1. Fairness requires that a party, having received only a fraction of the performance that he expected, not be asked to pay an identical fraction of the price that he originally promised on the expectation of full performance, unless it appears that the performance that he actually received is worth to him roughly the same fraction of what full performance would have been worth to him. iii. Whether a K is entire or divisible depends on the intention of the parties as disclosed by the language of the K, the manner in which it is to be performed, the method of payment, and the circumstances attending its execution and operation. 4. Total v. Partial Breach a. A breach is total if the breach is material and the breaching party fails to correct or cure the breach within a reasonable period of time. i. Duties a. A total breach relieves or discharges the non-breaching party from his duties under the K; after a total breach the non-breaching party is justified in refusing to perform his obligations and may even enter into alternative Ks. b. A partial breach does not discharge the non-breaching party, who must continue to perform his obligations under the K. 1. If the non-breaching party repudiates the K after a partial breach, this constitutes a total breach by him. ii. Damages a. After a total breach, the injured party is entitled to recover not only actual damages accrued as a result of the breach but also any future damages that will reasonably flow from the breach.

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b. A partial breach produces a right to damages only for the actual harm that has resulted to date, not for future harm. b. Material Breach i. When an uncured material breach by one party occurs, R2d 237 treats this as in effect the nonoccurrence of a (constructive) condition to the other partys duty to render any performance not yet due, and performance by that party may therefore be suspended until the breach is cured. ii. When a material breach becomes total, under the rule of R2d 242 it has the effect of discharging the other partys remaining duties of performance and permitting that party to proceed immediately to pursue a claim for damages from total breach (R2d 236(1)). iii. First Question: Is the other partys breach material? a. The following factors are considered: R2d 241 1. The extent to which the injured party will be deprived of the benefit which he reasonably expected; 2. The extent to which the injured party can be adequately compensated for the part of that benefit of which he will be deprived; 3. The extent to which the party failing to perform or to offer to perform will suffer forfeiture; 4. The likelihood that the party failing to perform or to offer to perform will cure his failure, taking account of all the circumstances including any reasonable assurances; 5. The extent to which the behavior of the party failing to perform or to offer to perform comports with standards of good faith and fair dealing. b. Some federal courts have employed a somewhat different, four-factor test: 1. Whether the breach operated to defeat the bargained-for objective of the parties; 2. Whether the breach caused disproportionate prejudice to the nonbreaching party; 3. Whether custom and usage consider such a breach to be material; and 4. Whether the allowance of reciprocal nonperformance will result in the accrual of an unreasonable and unfair advantage. iv. Second Question: Has the material breach become total? a. R2d 242 and comment b indicate that the totality of a breach will depend on the materiality factors listed in 241, plus these other considerations: 1. The extent to which further delay appears likely to prevent or hinder the making of substitute arrangements by the non-breaching party; and 2. The degree of importance that the terms of the agreement attach to performance without delay. 3. The reasonableness of the injured partys conduct in communicating his grievances and in seeking satisfaction. b. One partys repeated nonperformance notwithstanding his repeated expression of willingness to perform warrants an inference that the party did not intend to perform and constitutes a total breach. Sackett v. Spindler.

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v. Time is of the Essence / Express Time Condition Clauses a. R2d 242 comment d suggests that stock phrases such as time is of the essence in the K will not necessarily mean that any delay in performance must be deemed material; such phrases are to be considered along with other circumstances in deciding this question. b. On the other hand, R2d 242 comment d also indicates that the parties may make performance by a stated date an express condition to their agreement, in which case delay beyond that date (unless the condition is excused) will result in discharge. c. Exception: Installment Ks i. If the non-breaching party has fully performed his obligations under the K and the breaching partys only obligation is to pay money in installments, the injured party is required to bring a series of actions to recover unpaid installments as they accrue. R2d 243(3). a. To avoid this rule, Ks that call for the installment payment of money (such as promissory notes for the purchase of goods) usually contain an acceleration clause stating that if any installment is not paid on time, the creditor may elect to treat the entire balance as immediately due. R2d 243 comment d. B. Anticipatory Repudiation 1. Repudiation a. Language that under a fair reading amounts to a statement of intention not to perform except on conditions which go beyond the K constitutes a repudiation (question of fact). R2d 250 comment b; UCC 2-610. i. Many courts require the manifestation of intent not to perform be definite and unequivocal in order to constitute an anticipatory breach; mere doubtful and indefinite statements that performance may or may not take place may not be so regarded. R2d 250 comment b. ii. A suggestion for modification of the K does not generally amount to a repudiation. iii. A request for a change in the price term of a K does not generally constitute a repudiation. b. Conduct that renders the obligor unable or apparently unable to perform may amount to a repudiation. R2d 250(b). i. For mere conduct to constitute an anticipatory repudiation, it must indicate that performance is a practical impossibility. ii. Financial difficulty, even to the level of insolvency, does not constitute an anticipatory repudiation, but it does constitute a ground for demand of adequate assurance of performance. R2d 252 and comment a. a. If a party files a petition in bankruptcy, federal law determines the effect of the bankruptcy on the rights of the other party to the K. R2d 250 and comment c. c. After an anticipatory repudiation, the aggrieved party is entitled to choose to treat the K as rescinded or terminated (subject to possibility that repudiation will be retracted), to treat the anticipatory repudiation as a breach by bringing suit

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(immediately) or otherwise changing his position, or to await time for performance. 2. Retracting a Repudiation a. Retract before Change in Position or Notice that Repudiation is Considered Final i. The effect of a statement as constituting repudiation under R2d 250 or the basis for a repudiation under 251 is nullified by a retraction of the statement if notification of the retraction comes to the attention of the injured party before he materially changes his position in reliance on the repudiation or indicates to the other party (perhaps by notice or by bringing suit) that he considers the repudiation to be final. R2d 256(1). ii. Until the repudiating partys next performance is due, he can retract his repudiation unless the aggrieved party has since the repudiation cancelled or materially changed his position or otherwise indicated that he considers the repudiation final. UCC 2-611(1). 3. Demand for Adequate Assurances R2d 251; UCC 2-609 a. When reasonable grounds for insecurity arise with respect to the performance of either party, the other may, in writing, demand adequate assurance of due performance and until he receives such assurance, may if commercially reasonable, suspend any performance for which he has not already received the agreed return. UCC 2-609(1). i. (Maybe) In Writing a. Although the UCC requires that the request be made in writing, R2d does not, and courts have not strictly adhered to this formality as long as an unequivocal demand is made. ii. Reasonable Grounds a. Whether a party has reasonable grounds for insecurity is an issue of fact that depends on factors such as: 1. The other partys exact words or actions; 2. The course of dealing or performance between the parties; and 3. The nature of the K and the industry. 4. Significant financial difficulties will ordinarily amount to reasonable grounds for insecurity. 5. Failure to perform important obligations under the K may be a reasonable basis for insecurity. 6. Insecurity may also stem from the other partys failure to perform obligations under related Ks. 7. Unreliable rumors and insignificant risks do not constitute reasonable grounds for insecurity. 8. Reasonable grounds for insecurity can arise from the sole fact that a buyer has fallen behind in his account with the seller, even where the items involved have to do with separate and legally distinct Ks. UCC 2-609 comment 2. iii. Adequate Assurances a. Reasonableness and adequacy are defined by good faith and commercial standards rather than legal standards. b. Adequate assurances may be:

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1. Mere verbal guarantee; 2. Posting of a bond; 3. Requesting a letter of credit; 4. Verification of third-party credit, financing, or other guarantee; iv. Good Faith a. A demand for assurances must be made in good faith. UCC 2-609 comment 4; R2d 251 comment d. b. If a party demands and receives specific assurances, then absent a further change of circumstances, the assurances demanded and received are adequate, and the party who has demanded them is bound to proceed. v. Failure to Respond a. After receipt of a justified demand, failure to provide, within a reasonable time not exceeding 30 days (may be less under the circumstances), such adequate assurance of due performance is a repudiation of the K. UCC 2-609(4). b. R2d 251(2) requires a party to respond to a demand for assurances within a reasonable time but does not set a maximum period of time. vi. Permissive or Compulsory a. Some argue that in some circumstances, a request for adequate assurances should be required when a party is in breach. C. Express Conditions 1. When the parties have agreed that some event must take place before a party has an obligation to perform, the performance obligation is said to be subject to an express condition. Express conditions are those agreed to and imposed by the parties themselves. a. Strict Performance i. Express conditions must be literally performed, whereas constructive conditions are subject to the doctrine of substantial performance. a. When a K requires that written notice be given within a specified time, the notice is ineffective unless the writing is actually received within the time prescribed (despite the fact that timely oral notice may be given or that the K may lack a time is of the essence clause) provided there is no excuse such as waiver or forfeiture. Maxton v. LoGalbo; Oppenheimer v. Oppenheim. b. No Materiality or Substantial Performance Mitigation i. If the parties have made an event a condition of their agreement, there is no mitigating standard of materiality or substantiality applicable to the nonoccurrence of that event. R2d 237 comment d. a. Most courts adopt the strict performance rule but will use theories such as adverse interpretation, waiver, prevention, or avoidance of forfeiture to avoid enforcing immaterial, technical conditions. b. Some courts hold that the issue of materiality to be relevant to the question of how strictly a condition should be enforced. c. Effect of Non-occurrence

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i. Until the conditioning event does occur, the duty does not arise; at the point when it cannot (or for some reason clearly will not) occur, the obligor is discharged. R2d 225. 2. Interpretation a. Preference for Promise or Constructive Condition i. Courts will interpret doubtful language as embodying a promise or constructive condition rather than an express condition. This interpretive preference is especially strong when a finding of express condition would increase the risk of forfeiture by the obligee. R2d 227(1). b. Condition, Promise, Both, or Neither? i. Promise indicates that the party is under an obligation to perform. ii. Condition indicates that the other party need not perform unless the condition is satisfied. iii. If an event is a promissory condition, failure of the event to occur justifies the obligor in treating her obligations as discharged and also subjects the obligee to liability for damages. iv. In cases where K language links a subcontractors right to payment for work performed to the general contractors receipt of payment from the owner (a pay-when-paid clause), courts have generally interpreted such language as neither a condition nor a promise but as merely calling for payment within a reasonable time (absent strongnot boilerplateK language indicating that the subcontractor was assuming the owners credit risk). a. In some cases, where a debt exists but its payment is apparently conditioned on the happening of some event within the other partys control, the court may interpret the agreement as requiring payment within a reasonable time if the event does not occur (or that the other party has breached its duty of good faith by not expediting the occurrence of the event). c. Condition to One or Both Parties Duties? i. If the court decides that a condition applies to both parties duties, either one can insist on its non-occurrence as a ground for non-performance. ii. If it applies to only one partys duty, it is waivable by that party. a. If the condition is clearly for the benefit of one party only, it may be waivable by him. d. Unmistakable Language i. Interpretation as a means of reducing the risk of forfeiture cannot be employed if the occurrence of the event as a condition is expressed in unmistakable language. R2d 229 comment a. ii. Language such as if, unless and until, failure of the conditioning event will cause the agreement to be of no further force and effect, and neither party shall have any rights against nor obligations to the other indicate an express condition. 3. Excuses a. When nonoccurrence of a condition is excused, the conditional duty becomes an unconditional one, and the promisors failure to perform amounts to a breach. b. Waiver

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i. An obligor whose duty is expressly dependent on a condition may be under a duty to perform despite the non-occurrence of that condition, if a court finds that he has, by word or conduct, waived the right to insist on fulfillment of the condition before performing the duty. a. Waiver = an intentional relinquishment of a known right with knowledge of its existence and the intent to relinquish it.. b. A waiver is effective without either consideration or reliance, but only if the condition waived was not a material part of the performance that the obligor was to receive in exchange or a material part of the risk assumed (e.g., procedural or technical conditions). R2d 84(1). 1. Release of a K right (as distinguished from waiver of a condition) is not valid unless made for a valuable consideration. c. If the condition is material, the waiver must be supported by consideration or detrimental reliance on expression of intention not to insist on it. d. A K deadline may be waived by acts, words, or conduct inconsistent with the deadline. e. The existence of a waiver is generally a question of fact. ii. Retraction of Waiver a. If a waiver of a material condition is made in return for consideration, it should be both effective and non-retractable. b. If the waiver of a non-material condition is made after the time for fulfillment of that condition is passed, then the waiver should be nonretractable. c. If the waiver of a non-material condition is made before the time for fulfillment, and the obligor attempts to retract it while there is still time for the condition to occur, the retraction will be effective unless the obligees change of position in reliance on the waiver has made that unjust. R2d 84(2). d. UCC Rule: A party may retract a waiver unless retraction would be unjust in view of a material change in position in reliance on the waiver. 2209(5). c. Prevention i. A condition is excused if the promisor wrongfully hinders or prevents the condition from occurring. R2d 245. a. In order to determine whether an obligors prevention of the occurrence of a condition is wrongful, it is necessary first to ascertain what degree of obligation (if any) the obligor has with respect to the happening of the condition in question. 1. Where the conditioning event is to some extent within the obligors control, the obligor is likely to have at least the obligation to attempt to cause the condition to occur. 2. Even if the event is not within the obligors control, she may be under an obligation (express or implied) to cooperate with the obligee in causing the condition to happen, or at the minimum not to impede those efforts.

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b. However, courts have frequently held that the possibility of prevention of the condition by the obligor was a risk assumed by the obligee, and thus not wrongful. d. Avoidance of Forfeiture i. A court may excuse the non-occurrence of a condition where forfeiture would otherwise result, unless the conditioning event was a material part of the parties exchange. R2d 229. a. Forfeiture = the denial of compensation that results when the obligee loses its right to the agreed exchange after it has relied substantially, as by preparation or performance, on the expectation of the exchange. R2d 229 comment b. 1. R2d definition of forfeiture is broad enough to encompass reliance losses in general, not only those that may have enriched the obligor. ii. Negligent Failure to Exercise an Option a. Notice exercising an option is ineffective if it is not received by the offeror within the time specified. R2d 63(b). 1. Loss of the option does not ordinarily result in the forfeiture of any vested rights. b. Lease Renewal Option 1. SPLIT: Courts are divided on the issue whether a tenants negligent failure to give timely notice to renew a lease should be excusable on some basis. a. A tenant or mortgagor should not be denied equitable relief from the consequences of his own neglect or inadvertence if a forfeiture would result, even if he breaches a covenant in the agreement, unless the lessor would be prejudiced. JNA v. Cross Bay Chelsea. i. Negligentbut not intentional or bad faithdelay by the lessee may be excused. ii. Forfeiture may be lessees loss of money invested in the leasehold or customer goodwill from having a long-standing interest in the location. iii. Prejudice may arise because lessor made other commitments for the property relying in good faith on the lessees apparent default. c. Option to Purchase Real Estate 1. Courts almost uniformly have denied equitable relief to an option holder who fails to comply with the time period set forth in the option. 2. Exception: Lease with an Option to Buy a. Some courts have followed JNA by giving a prospective purchaser an enforceable right to exercise an option to buy property contained in a lease, despite some defect in the prospective purchasers exercise of the option, when she has already been in possession of the property. e. Adverse Interpretation

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i. Interpretation rules are used to approximate what the parties would have expressly provided with respect to a contingency that they did not foresee, if they had foreseen it. a. Form K language will be scrutinized to determine whether it really was intended to apply to the condition. ii. Satisfaction of a Party a. MIN (subjective test): Some cases hold that if the K provides that the sellers performance must be to the buyers satisfaction, his rejection however unreasonableof the sellers performance is not a breach of the K unless the rejection is in bad faith. 1. If one party has unlimited power to reject the others performance as unsatisfactory, he may have made an illusory promise of performance; therefore, a duty to act at least in good faith is implied. 2. The standard of good faith is employed when the K involves personal aesthetics or fancy. 3. The subjective standard should be used only where the agreement leaves no doubt that it is only honest dissatisfaction that is meant and no more. R2d 228 comment a. 4. Where personal services are involved, the court may be more likely to approve the use of a subjective standard. 5. Where the K conditions performance by one party on the others performance to the satisfaction of some independent third party (such as an architect or engineer), there is a greater tolerance for the application of a subjective test because there is less likelihood that the third party will be affected by the selfish interests of the obligor. R2d 227 comment b illustration 3, 228 comment b. b. MAJ (objective test): If it is practicable to determine whether a reasonable person in the position of the obligor would be satisfied, an interpretation is preferred under which the condition [that the obligor be satisfied with the obligees performance] occurs if such a reasonable person in the position of the obligor would be satisfied. R2d 228. 1. The reasonable person standard is employed when the K involves commercial quality, operative fitness, or mechanical utility which other knowledgeable persons can judge. 2. The objective test may be justified by a desire to avoid forfeiture. R2d 228 comment b. c. No UCC provision deals directly with K terms requiring satisfactory performance. 1. UCC defines a sale on approval but takes no position on whether satisfaction means reasonable satisfaction where an industrial machine is involved. UCC 2-326 comment 1. 2. UCC requires at least honesty in fact under good faith obligation and may also require fair dealing in the trade. UCC 1-203(1)(b). VII. Expectation Damages: Principles and Limitations A. Remedies

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1. A party aggrieved by nonperformance will ordinarily be entitled to some remedy, even if only nominal damages. R2d 346(2). 2. Interests the Law Seeks to Protect R2d 344 a. Restitution Interest i. P has in reliance on Ds promise conferred some value on D. ii. The court may force the D to disgorge the value he received from P to prevent unjust enrichment. b. Reliance Interest i. P has in reliance on Ds promise changed his position. ii. The court may award damages to P to undue the harm which such reliance caused P. c. Expectation Interest i. The court may seek to give P the value of the expectancy which Ds promise created. ii. Through specific performance or money damages, the courts object is to put P in as good a position as he would have been in had D performed his promise. B. Computing the Value of Ps Expectation 1. Benefit of the Bargain Rule a. It has long been the policy for a court in a breach-of-K suit to attempt, if possible, to compute and award damages so as to give P his expectation of gain under the K: the benefit of the bargain that P would have realized had the agreement been fully performed. R2d 347. i. Awarding less or more than injury to Ps expectation may be reversible error. 2. Expectation Damages Formula R2d 347 a. General Measure = Loss in Value + Other Loss - Cost Avoided - Loss Avoided (in an action for partial breach, only the first two factors apply) i. Loss in Value: difference between the value of performance that should have been received less the value of what, if anything, actually was received. ii. Other Loss: includes incidental damages (costs incurred after the breach in a reasonable, but possibly unsuccessful, attempt to avoid the loss) and consequential damages (injury to person or property caused by the breach). iii. Cost Avoided: if injured party terminates and claims damages for total breach, the breach may have a beneficial effect on that party by saving it the further expenditure that would otherwise have been incurred. a. Fixed costs and overhead are not generally costs avoided (would have incurred them irrespective of breach or performance). iv. Loss Avoided: if injured party terminates and claims damages for total breach, the breach may have a further beneficial effect by allowing the party to avoid some loss by salvaging and reallocating some or all of the resources that otherwise it would have had to devote to performance of the K. 3. Although they get to the same answer as the above formula, in some cases, the formula is stated differently: a. Real Estate i. Difference between the K price and the market price at time of breach + special damages as a result of the breach.

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ii. Difference in Value a. When the buyer breaches, the seller must prove that the property was worth less on the market than the K price. b. When the seller breaches, the buyer must prove that the property was worth more on the market than the K price. 1. English Rule a. Many courts have traditionally restricted the plaintiff purchaser to only restitution damages of any payments made by him on the purchase price, unless he can demonstrate that the defendant seller has breached in bad faith. 2. American Rule a. Plaintiff purchaser can obtain expectation damages for any unexcused failure to convey, regardless of the good faith or bad faith of the seller. 3. Uniform Land Transactions Act 2-510 a. Awards loss of bargain damages to plaintiff purchaser but limits his remedy to restitution of payments (plus incidental damages) in cases where the sellers failure to convey stemmed from a title defect of which he had no knowledge at the time of contracting. c. Although real estate appraisers may provide evidence of market value, many courts allow evidence of market value from non-experts, such as the property owner. 1. Many courts allow evidence of the propertys resale value if the resale occurred at an arms length and within a reasonable period of time to the breach. iii. Special Damages (consequential + incidental) a. Damages are recoverable only if they were reasonably foreseeable at the time of the K; b. Speculative damages are prohibited; and c. Injured party has a duty to mitigate damages: damages are not recoverable to the extent they could have been avoided or minimized by reasonable efforts. b. Employment i. An employer may recover damages from an employee who has failed to perform an employment K. a. At-Will v. Fixed-Term Employment 1. Although there are many restrictions on an employers right to terminate an at-will employment K, there appears to be no corresponding movement toward similar restrictions on termination by the employee. 2. The employer will generally only be able to recover damages where the employee has entered a fixed-term K. ii. Specific Performance a. Courts will almost never order specific performance by an employee of the services promised in a K of employment. iii. Expectation Damages

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a. Damages include the cost of obtaining other services equivalent to that promised but not performed, plus any foreseeable consequential damages. b. If an employer is forced to hire a more experienced replacement (and pay him more money) the excess is recoverable from the breaching employee because the employers original bargain (the benefit of which he is entitled to receive) was to receive Ds services at the K price. Handicapped Childrens Education Board v. Lukaszewski. 1. An injured party must take all reasonable steps to mitigate its damages, so the employer must attempt to obtain equivalent services at the lowest possible cost. c. Construction i. The general rule for breach of a construction K is that the injured party may recover those damages which are the direct, natural, and immediate consequence of the breach and which can reasonably be said to have been in the contemplation of the parties when the K was made. a. Damages = Builders expected net profit on the entire K plus the builders unreimbursed expenses at the time of breach. ii. If the loss in value to the injured party is not proved with sufficient certainty, damages may be measured by either: a. The diminution in market value; or b. The reasonable cost of completing performance or of remedying the defects if that cost is not clearly disproportionate to the probable loss in value to him. R2d 348(2). iii. Cost to Complete Rule a. MAJ: Generally, where a builders performance has been defective or incomplete, the reasonable cost of replacement or completion is the measure of damages. iv. Diminution in Value Rule a. When there has been a substantial performance in good faith but defects exist, the correction of which would result in unreasonable economic waste, courts have measured the damages as the difference between the value of the property as constructed and the value if performance had been properly completed. Jacobs & Young. b. Economic Waste 1. The economic waste of the type which calls for application of the diminution in value rule generally entails defects in construction which are irremediable or which may not be repaired without a substantial tearing down of the structure. 2. Disparity in relative economic benefits is not the equivalent of economic waste. c. Breach of Covenant Incidental to Main Purpose of the K 1. Where the breach of a covenant which is only incidental to the main purpose of the K and completion would be disproportionately costly, courts have applied the diminution in value measure even where no destruction of the work is entailed. d. Good Faith

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1. A builder who asks the court to apply the diminution in value rule as an instrument of justice must not have breached the K intentionally and must show substantial performance in good faith. v. Choosing Between Replacement Cost / Diminution in Value Rules a. Whether owner plans to use the property for personal rather than business use. b. Whether there is nonpecuniary, subjective value of the property to the owner. c. Whether there is a public interest at stake beyond just the builder and the owners interests. d. Whether P will pocket the award and be unjustly enriched (if P really wanted the property restored, he would have brought an action for specific performance). e. Whether D has pocketed any of the K price and is unjustly enriched by not performing. f. Whether the diminished value award is more economically efficient. g. Whether because of Ps duty to mitigate damages, he should be limited to only those actual damages suffered (lower of reduction in FMV or cost of performance). h. Other Choices 1. Some commentators suggest that courts should be allowed to award any reasonable compromise between the two alternatives; 2. Others argue that where P desires cost-to-complete damages, specific performance should be awarded, and the parties will negotiate a buyout. 4. UCC a. Damages for breach of K to buy or sell goods under the UCC are measured by the difference between the market price and the K price of the goods. b. Sellers Damages for Nonperformance by Buyer i. General Rule a. Damages equal the market price at the time and place for tender less the unpaid K price plus any incidental damages less expenses saved as a consequence of buyers breach. UCC 2-708(1). ii. Sellers Resale Rule a. As an alternative measure of damages, the seller who complies with the provisions of UCC 2-706 may recover from a breaching buyer damages measured by the difference between the K price and the sellers resale price. c. Buyers Damages for Sellers Breach i. General Rule a. Damages equal the market price at the time when the buyer learned of the breach and the K price plus incidental and consequential damages less expenses saved as a consequence of sellers breach. UCC 2-713. ii. Buyers Substitute Goods Rule

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a. UCC 2-712(1) allows the buyer to cover its loss by purchasing substitute goods and to measure its damages by the difference between the cost of those goods and the K price. 5. Interest on Damages a. Post-judgment Interest i. When P is successful in recovering any judgment in a court action, postjudgment interest will under local law usually accrue with respect to the amount of that judgment at least from the date of entry, perhaps from the date of verdict. b. Pre-judgment Interest i. Agreements may call for the payment of interest if sums due under the agreement are not paid by a specified date. Such a provision will be given effect in the judgment unless it violates some usury statute. ii. In the absence of K language so providing, P may sometimes recover prejudgment interest but only in cases where at the time of the breach, Ps claim was for a liquidated sum or at least was for a sum that was in the courts view readily ascertainable. C. Restrictions on the Recovery of Expectation Damages 1. Foreseeability, Certainty, Causation, and Reasonableness a. General Damages i. General damages are those that arise naturally from the breach and are independent of the particular circumstances of the injured party. P need not make any special showing to recover general damages. a. No party to a K may recover more in damages for a breach of the K than might have been gained by full performance (e.g., if there is a cancellation provision, the damages would be calculated assuming the breaching party would have cancelled pursuant to that provision). ii. Foreseeability R2d 351; UCC 2-715(2). a. Where two parties have made a K which one of them has broken, the damages which the other party ought to receive in respect of such breach of K should be such as may fairly and reasonably be considered either arising naturally, i.e., according to the usual course of things, from such breach of K itself, or such as may reasonably be supposed to have been in the contemplation of both parties, at the time they made the K, as the probable result of the breach of it. Hadley v. Baxendale. b. Elements: 1. Damages were in contemplation of the parties at the time the K was made; 2. The type of loss (not the manner) was foreseeable; 3. The focus of foreseeability is on the breaching party; 4. The standard of foreseeability is at least in part objective (the breaching party is liable for losses about which it had reason to know); and 5. The loss must be foreseeable as a probable result of the breach. b. Special / Consequential Damages

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i. Special, or consequential, damages are those that flow from the specific circumstances of the injured party (e.g., lost profits, personal injury, property damage ii. MAJ: If the special circumstances under which the K was actually made were communicated by P to D, and thus known to both parties, the damages resulting from the breach would be the amount of injury which would ordinarily follow from a breach under these special circumstances. iii. MIN: Tacit Agreement Rule (largely rejected by modern courts) a. The injured party would have been required to show not only that the special circumstances were brought to the attention of the other party, but also that the other party assumed consciously the liability in question. iv. Reasonable Certainty a. An injured party cannot recover damages that are speculative. P must prove its damages with reasonable certainty. R2d 352. 1. Fact of Damage; a. In order for damages to be recoverable for a breach of K, they must be clearly ascertainable, in both their nature and origin, and it must appear that they are the natural and proximate consequence of the breach and not speculative and contingent. b. When P establishes the fact of damage, the jury is given wide leeway in awarding compensation. 2. Amount of Damage a. Proof of lost profits typically requires expert testimony, and experts can vary widely in their assumptions and their resulting projections of future lost profits. b. In computing expected lost profits, P may only recover net as opposed to gross profits. c. P may generally only be allowed to recover either the decline in market value of the business or the present value of the lost future net income (theoretically, these should be equal [in a non-taxable business entity]). d. New Business Rule i. Courts have often declined to award lost profits to a new business venture with no history of prior profitability as a matter of law. ii. Many recent decisions, however, have rejected a strict application of this rule. e. The amount of the damage award must be reasonable. v. Disclaimers or Limitations on Consequential Damages a. Transactions governed by the UCC have specific rules governing contractual disclaimers of warranties (2-316) or limitations of remedies for breach of warranty (2-719). 1. Both federal and state statutes may regulate disclaimers and limitations of remedies in consumer transactions. 2. Where UCC or statutory law is inapplicable, general contractual principles apply.

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b. Consequential damages are limited in cases where justice so requires in order to avoid disproportionate compensation. R2d 351(3). 1. This limitation is intended to apply in cases where there is extreme disproportion between the price charged by D under the K and the liability sought to be imposed on it. 2. Informality of agreement and a noncommercial setting ought to be factors tending toward application of the suggested limitation. c. Breach of Promise to Pay Money (loan or purchase goods/svcs/prop) 1. Ps sometimes seek to recover consequential damages for losses claimed to have resulted from the breach of promises to pay money. a. Such claims have often run afoul of the requirements of mitigation or foreseeability. 2. Damages for breach of K to lend money are in most cases limited to the small additional amount that it would ordinarily cost to get a similar loan from another lender. In some cases, however, the lender may have reason to foresee that the borrower will be unable to obtain a loan elsewhere, in which case the lender may be liable for much heavier damages. R2d 351 comment e. a. Courts are willing to uphold such claims, providing the requirements of foreseeability, certainty, and mitigation are met. d. Breach of Personal Services K by Employer 1. Court usually awards wages under the K less sums P might have realized through mitigation. 2. P may sue for lost opportunities, though. a. Claims for general damage to reputation or loss of publicity have usually been denied in American courts. b. If P can show a specific loss, however, the chances of success are greater. c. International Transactions Article 74 of CISG i. Damages for breach of K by one party consist of a sum equal to the loss, including loss of profit, suffered by the other party as a consequence of the breach. Such damages may not exceed the loss which the party in breach foresaw or ought to have foreseen at the time of the conclusion of the K, in the light of the facts and matters of which he then knew or ought to have known, as a possible consequence of the breach of K. 2. Mitigation of Damages (Minimization of Damages / Avoidable Consequences Doctrine) a. General Rule i. If P in a K action reasonably could have mitigated his damages, but fails to do so, then he will be unable to shift that portion of his loss to D and will be forced to absorb it himself. R2d 350 comment b. b. Effect of Repudiation i. After an absolute repudiation or refusal to perform by one party to a K, the other party cannot continue to perform and recover damages based on full performance. c. Employment Ks

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i. An employee who has been wrongfully terminated has a duty to mitigate damages through reasonable efforts to achieve other employment: a. The general rule is that the measure of recovery by a wrongfully discharged employee is the amount of salary agreed upon for the period of service, less the amount which the employer affirmatively proves the employee has earned or with reasonable effort might have earned from other employment. Boehm v. ABC. ii. Failure to Accept Other Offers a. Comparable / Substantially Similar Job 1. The failure to accept offers of employment is significant in consideration of mitigation only if the former employer shows that the other employment was comparable, or substantially similar, to that of which the employee has been deprived in terms of location, type of services, hours of work, and status. Parker v. Twentieth Century-Fox. 2. The employer bears the burden of proving that comparable or substantially similar employment was available to the employee (this is a question of fact). b. Voluntary Removal from Job Market 1. The burden of establishing that the employee failed to exercise reasonable diligence in seeking suitable, alternative employment is on the employer (this is a question of fact). a. Some courts go further and impose on the employer the burden of proving that not only the employee failed to act reasonably in seeking other jobs but also that such efforts were likely to have been successful. c. Offer by Same Employer 1. Absent special circumstances, an employers potential backpay liability ceases to accrue at the time the claimant rejects an employers unconditional offer of either the same job as, or one substantially equivalent to, the job from which the claim arose. Ford Motor v. EEOC. a. Special Circumstances i. Once the employer has carried the burden of proving that a substantially equivalent job was available to the employee, the employee has the burden of proving that special circumstances justified a rejection of the offer. iii. Front Pay a. The court may award D, who has been wrongfully discharged, damages for income that he would have earned had he not been discharged starting from the date of the judgment through the expected date when he will obtain a substantially equivalent position or retirement, whichever is sooner. iv. Incidental Losses a. A wrongfully terminated employee may recover costs such as travel costs and employment agency fees incurred in seeking new employment. R2d 347 comment c.

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v. Accepting Less Than Comparable Employment a. Although an employee has no duty to accept a position that is not comparable to his former position, if he does, the amounts earned therefrom are likely to be set off against his damages recoverable for the breach of K (this is a loss avoided or gain made possible). 1. There are some situations, however, in which a new K entered into after breach will not be considered to be a mitigating one, e.g., if the employee could have earned the money from the new K while still employed at the old job (a moonlighting job) or the injured party is a lost volume seller or lessee (see below). vi. Collateral Source Rule a. In tort law, under the collateral source rule, an injured partys recovery against a tortfeasor is not reduced by payments received from sources that are wholly unrelated to the tortfeasor, such as payments under disability insurance policies. b. Some courts have refused to extend this doctrine to K cases and have held that an employees unemployment compensation should reduce the amount of damages recovered from an employer. 1. Some courts do not reduce damages for social security and pension payments, which are based on joint employer/employee contributions rather than unemployment insurance, which is funded solely by employer contributions. d. UCC i. Although the UCC has no provision imposing a general responsibility of mitigation on the parties to a sales K, UCC 1-106 comment 1 indicates this notion was intended to be subsumed in the more general principle that remedies are to be limited to compensation. The comment also suggests that minimization of damages may be implicit in the more general obligation of good faith imposed by 1-203. e. Real Estate Leases i. MIN: Some courts adhere to the traditional rule that defaulting tenants are held to their obligation to pay the rent in full, with no obligation on the landlord to minimize loss. ii. MAJ: Most American jurisdictions have adopted the position that real estate leases should be treated more like commercial Ks, with the landlord in the event of the tenants abandonment having a duty to mitigate similar to that imposed on other contracting parties. f. Lost Volume i. In order for the breaching party to obtain a deduction from its damage liability for income received by the non-breaching party from another K, the breaching party must show that the other K was a mitigating K (one that the nonbreaching party was able to perform only because the breach freed him from his obligation) rather than an additional K, in which case, the non-breaching party is entitled to profit from both Ks. a. Whether the new K is mitigating or additional is a question of fact.

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b. If the non-breaching party would have entered into both transactions but for the breach, he has lost volume as a result of the breach. In that case, the second transaction is not a substitute for the first. R2d 350 comment d. ii. To establish status as a lost volume seller, seller must prove: a. That it possessed the capacity to make the additional sale; b. That it would have been profitable for it to make an additional sale; and c. That it probably would have made the additional sale absent the breach. iii. UCC a. Courts have been almost unanimous in holding that lost volume sellers of goods are entitled to recover their profit under UCC 2-708(2). iv. Personal Services a. A new K entered into after a breach of a personal services K will generally be considered mitigating unless it would have been possible for the nonbreaching party to have performed both Ks simultaneously. v. Non-Personal Services a. When the K does not require personal services, a second K entered into after the breach of the first K will not be considered to be a mitigating one if the provider of services has the capacity to perform both Ks. Jet Service v. Salina Properties. 1. Ability to employ others to perform both Ks shows capacity. g. Costs to Be Considered in Profit i. Some courts award gross profit from a breached K = sales price less variable costs. Generally, fixed costs are not deducted in determining the award. D. Nonrecoverable Damages 1. Attorneys Fees a. American Rule i. Each party bears its own expenses of litigation: successful litigants in civil actions and declaratory judgments may not generally recover their attorneys fees and expenses except in very limited cases or pursuant to an agreement between the parties, statute, or rule. a. A successful party to an ordinary K claim will not, in the end, receive his full expectation damages because party of his award will be used for litigation expenses. b. Exceptions i. K Provision a. Where the K at issue expressly provides for an award of attorneys fees to the prevailing party, the court should enforce the promise. 1. However, some courts hold that such provisions violate public policy or should not be enforced under the circumstances (e.g., P refuses generous settlement offer preferring instead to litigate). 2. Statutes in some states may invalidate attorneys fees provisions. b. If the K contains a provision providing for attorneys fees, the prevailing party may recover even if the K is rescinded or declared unenforceable so long as the K was not void (never came into existence).

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c. Battle of the Forms 1. Under the battle of the forms, an attorney fee provision found in one of the parties forms may fail to become part of the K. 2. SPLIT: Whether an additional provision found in an acceptance providing for recovery of attorneys fees becomes part of the K between merchants or is excluded under UCC 2-207(2)(b) because it amounts to a material alteration of the K. ii. Statute a. Numerous federal and state statutes, covering the entire range of economic activityconsumer protection, civil rights, environmental protection, employment law, and securities regulationauthorize courts to grant attorneys fees. 1. A Texas state laws allows for award of attorneys fees when payment is demanded on an oral or written K and not tendered within 30 days (applies to promissory estoppel, too). b. Implied Reciprocal Agreement 1. Some state statutes provide that if a K includes a provision for recovery of attorneys fees by one party, it is deemed to provide for recovery of fees by the prevailing party. iii. Court Rules a. The Fed. Rul. of Civ. Pro. and many state rules provide a number of provisions allowing courts to award attorneys fees against an attorney or party who engages in improper litigation procedure or makes a frivolous appeal. 1. Federal courts have inherent power to impose sanctions for bad faith conduct, even when the conduct is not specifically covered by rules of procedure or statutory provisions, including fraud that occurs outside court. Chambers v. Nasco, 501 U.S. 32. b. Professional Rules of Conduct 1. Lawyers who engage in improper litigation may be subject to professional discipline. iv. Insurance Companies a. Establishing Duty to Defend & Failure to Defend Policyholder 1. Statutory Rule a. Several jurisdictions have a statute or rule pursuant to which courts award insureds their attorneys fees and expenses in declaratory judgment or other actions that establish an insurers duty to defend. Typically, these statutes require some form of bad faith by the insurer. 2. No Statute / No Recovery a. In the absence of a statute, rule, or agreement, some courts apply the traditional rule to deny recovery of attorneys fees and expenses in actions against insurers. 3. No Statute / Bad Faith Rule

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a. In the absence of a statute, some courts allow recovery if there is a showing that the insurer has acted fraudulently or in bad faith or has been stubbornly litigious. 4. No Statute / Special Relationship Rule a. Other courts state that a special relationship exists between an insurer and an insured under a homeowners or similar type of insurance policy which should permit an insured to recover attorneys fees and expenses incurred in establishing the insurers duty to defend. b. An insurance companys unjustified refusal to defend its policyholder makes it liable to him for the expenses which he incurred by reason of having to retain his own counsel to defend against a third party and to then sue the insurance company to establish its obligation to indemnify him. Preferred Mutual v. Gamache. i. The insurance company could have defended the policyholder under a reservation of rights. v. UCC a. MIN: Some contend that the UCC provides for or at least permits the award of attorneys fees to a victorious P, either as incidental or consequential damages. UCC 2-710, 2-715. Such claims have usually been unsuccessful. c. Punitive Damages i. In a few states, punitive damages may be awarded to compensate the prevailing party for attorneys fees that would otherwise go uncompensated under the American Rule. d. Collateral Litigation i. When Ds breach of K causes P to sue or be sued in another case with a third party, P may recover legal expenses (including attorneys fees) incurred in prosecuting or defending the collateral litigation made reasonably necessary by Ds breach, if the requirements of foreseeability and certainty are satisfied. R2d 351 comment c. 2. Tort Damages: Punitive Damages and Mental Distress a. Breach of K as a Tort i. Courts will generally enforce the breach of a K promise through K law, except when the actions that constitute the breach violate a social policy that merits the imposition of tort remedies. a. Examples: 1. Where a breach of duty directly causes physical injury; a. Mental distress damages are not generally allowed in tort for purely economic or property loss caused by negligence. 2. For breach of the covenant of good faith and fair dealing in insurance Ks; a. Almost all states recognize a tort where an insurance company in bad faith refuses or fails to settle a claim with a third party, and about half of the states recognize the tort where the insurance

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company is dealing directly with the policyholder (first-party claims). 3. For wrongful discharge in violation of fundamental public policy; or a. Some states do not recognize the tort of breach of the covenant of good faith and fair dealing in employment Ks. 4. Where the K was fraudulently induced. ii. Where Tort Damages May Be Allowed a. Negligent Breach of K + Independent Duty 1. A K obligation may create a legal duty, and the breach of that duty may support an action in tort. However, conduct amounting to a breach of K becomes tortious only when it also violates a duty independent of the K (a special relationship) arising from principles of tort law. b. Intentional Torts or Intent to Cause Harm 1. Generally, outside of the insurance context, a tortious breach of K may be found when: a. The breach is accompanied by a traditional C/L tort, such as fraud or conversion; b. The means used to breach the K are tortious, involving deceit or undue coercion; or c. One party intentionally breaches the K intending or knowing that such a breach will cause severe, unmitigable harm in the form of mental anguish, personal hardship, or substantial consequential damages. iii. Bad Faith Denial of K a. Only one state, Montana, recognizes the tort of bad faith denial of a commercial K, and there it the tort requires a showing of a special relationship between the contracting parties. b. California overruled a prior decision adopting the tort in favor of a general rule precluding tort recovery for non-insurance K breach, at least in the absence of violation of an independent duty arising from principles of tort law other than the bad faith denial of the existence of, or liability under, the breached K. Freeman & Mills v. Belcher Oil. iv. Punitive Damages for Breach of K a. Punitive damages may be recoverable if the breach in question is also a tort for which punitive damages would be available. R2d 355. b. Some courts allow punitive damages for breach of K that involves a breach of a fiduciary duty, fraud, or an overreaching commercial organization. b. General Torts Dealing with Emotional Distress i. Intentional Infliction of Emotional Distress a. One who by extreme and outrageous conduct intentionally or recklessly causes severe emotional distress to another is subject to liability for such emotional distress, and if bodily harm to the other results from it, for such bodily harm. R2d Torts 46. ii. Negligent Infliction of Emotional Distress

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a. An actor who is negligent is liable for damages for emotional distress if the distress is accompanied by bodily harm or other compensable damage but is not generally liable if the negligence produces only emotional distress. R2d Torts 436, 436A. c. Mental Distress as a K Damage i. Recovery for emotional disturbance will be excluded unless the breach also caused bodily harm or the K or the breach is of such a kind that serious emotional disturbance was a particularly likely result. R2d 353. a. Bodily Injury b. Emotional Disturbance was Particular Likely Result 1. When the express object of the K is the mental and emotional wellbeing of one of the parties, the breach of the K may give rise to damages for mental suffering or emotional distress because these would be contemplated or foreseeable consequential damages. a. Examples: i. Ks of carriers and innkeepers with passengers and guests; ii. Ks dealing with the carriage or disposition of dead bodies; iii. Ks for delivery of messages concerning death. b. Housing Construction Ks (SPLIT) i. Some courts hold that emotional distress damages are not available for breach of K to build a home because the essence of K is not emotional concerns and such damages would not be clearly ascertainable and would impose too many economic costs on all housing consumers. Erlich v. Menezes. ii. In a few jurisdictions, recovery for mental distress occasioned by improper construction of a residence appears to be more or less routinely available, even without facts indicating a special vulnerability on Ps part. E. Justifications for the Expectation Damage Rule 1. Protecting the Expectation Interest Under a Wholly Executory K a. Fuller & Perdue i. Psychological View a. Whether or not he has actually changed his position because of the promise, the promisee has formed an attitude of expectancy such that a breach of the promise causes him to feel that he has been deprived of something that was his. ii. Will Theory of K Law a. This theory views the contracting parties as exercising, so to speak, a legislative power, so that the legal enforcement of a K becomes merely an implementing by the state of a kind of private law already established by the parties. iii. Economic or Institutional Approach a. It is inevitable that the expectancy created by an enforceable promise should be regarded as a kind of property, and breach of the promise as an injury to that property.

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1. However, the promise may be viewed as property because the law enforces it. iv. Juristic View a. The normal rule of recovery is justified in some policy consciously pursued by the courts or other lawmakers. 1. Policy in favor of preventing and undoing the harms resulting from reliance. a. Expectation damages may be the most effective way to compensate the promisee for foregoing other opportunities, the damages from which would be difficult to measure or prove. 2. Policy in favor of promoting or facilitating reliance on business agreements. a. When business agreements are not only made but are also acted on, the division of labor is facilitated, goods find their way to the places where they are most needed, and economic activity is generally stimulated. b. Atiyah i. In practice, parties may expect wholly executory Ks to be able to be canceled with minimal penalties. c. Eisenberg i. Surrogate Cost Theory a. Assured protection of the full cost of reliance. ii. Facilitation of planning (by deterring breach in most cases) iii. Protection of risk allocation that the K was created to effectuate 2. Encouraging Breach of K: The Theory of Efficient Breach a. Holmes i. Nowhere is the confusion between legal and moral ideas more manifest than in the law of K. The duty to keep a K at C/L means a prediction that you must pay damages if you do not keep itand nothing else. b. Posner i. K law should not compel a buyer or seller to complete performance under a K when the other party has breachedthis would cause waste or excessive cost. The non-breaching party should simply be entitled to his damages and both parties should move on. ii. Sometimes it will be more profitable for a party to breach and pay damages in order to enter into a more lucrative K. iii. Critics a. Some say that transaction costs are not always fully considered (attorneys fees, intangible costs, etc.) by the breach damages, so the non-breaching party will generally be undercompensated. 1. Some would award supercompensatory damages to take these transaction costs into account. b. Some argue for specific performance because the parties will then negotiate a buy-out of the K, and some of the extra profits from the new K will go to the non-breaching party.

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c. Some say that K rights are like property rights, of which a party should not be deprived without his consent. d. Some say the law should promote fairness and justice rather than economics. e. Some say breach should be classified as willful and nonwillful, with the former leading to specific performance or the highest compensatory award and punitive damages when a willful breach is made with unreasonable disregard to the other party. iv. Few courts have expressly relied on efficient breach theory to decide cases. 3. Disgorgement of Gains Made Possible By Breach a. Value of Replacement Services i. The value of a lost employees services may be assumed to be the salary at which he finds replacement work. The employer may be entitled to recover the difference between the original K salary and the employees new salary for the remainder of the K term if the employee breaches and the employer cannot find a suitable replacement. Roth v. Speck. b. Value of Land i. In computing damages for a sellers wrongful refusal to convey land, a court may employ as a measure of market value the higher price that the seller received in selling to another. ii. When the purchaser is the breaching party, courts also often use the sellers resale price as evidence of market value in determining the sellers damages. c. Third-Party Interference with K i. Some commentators say that in exceptional circumstances deterrent considerations may justify restitution (disgorgement of profits made possible by the breach) not only against the third party who induced the breach but also against the other party to the K. d. Abuse of K i. Some commentators say that a party who intentionally breaches a K knowing that the damage award for diminution in value will be less than his cost savings should be required to disgorge his entire cost savings because of the strong moral argument in favor of this remedy. VIII. Alternatives to Expectation Damages A. Modern K law recognizes three interests as the basis for awarding damages: expectation, reliance, and restitution. 1. While it does appear that full compensation for lost expectation will compensate Ps reasonable reliance, it does not follow that the expectation interest will necessarily be greater than the interest generated by reliance. B. Reliance Damages 1. Where Anticipated Profits Are Too Speculative a. Ordinarily, profits lost due to a breach of K are recoverable. Where anticipated profits are too speculative to be determined, monies spent in part performance of, in preparation for, or in reliance on the K are recoverable. Wartzman v. Hightower. b. Exception: Loss K

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i. If it can be shown that full performance would have resulted in a net loss, P cannot escape the consequences of a bad bargain by falling back on his reliance interest. ii. A K is not necessarily a losing one merely because reliance costs exceeded the K price. 2. Measure of Reliance Damages R2d 349 a. Injured party has a right to damages based on his reliance interest, including: i. Expenditures made in preparation of performance or in performance; a. Generally includes out-of-pocket expenses and may take into account the gains P would have made had she not relied on the promises of D. ii. Less: any loss that the party in breach can prove with reasonable certainty the injured party would have suffered had the K been performed. b. Limitations i. Causation, mitigation, foreseeability, and certainty doctrines apply to limit recovery of reliance damages. ii. Equal Opportunity Exception to Mitigation a. Some courts hold that mitigation of damages does not apply where both parties have an equal opportunity to mitigate damages. If D rejects Ps request to assume the costs of the mitigation, D is estopped from asserting Ps failure to reduce its loss. b. This rule is somewhat illogical, though, because D always has the availability to mitigate damages by merely performing. 1. The better factor would be whether P was unable to mitigate (no money, time, etc.) particularly if Ps inability to mitigate were caused by Ds actions or inactions. iii. Costs before K Made a. Courts may not allow a party to recover for reliance costs incurred before the K is made. iv. Prejudgment Interest a. Prejudgment interest is generally not awarded because the reasonable and justified damages are not ascertainable until the jury renders its verdict. v. Old Rule: Limitation to K Price a. Under the original Restatement, reliance damages as an alternative to expectation damages were stated to be not recoverable in excess of the full K price promised by D. vi. Essential v. Incidental Reliance Damages a. Some argue that essential but not incidental reliance damages should be compensated. 1. Essential = performance, preparation to perform, costs (perhaps opportunity costs) of entering into the K. 2. Incidental (consequential may be better term) = costs that flow naturally (foreseeably) from the K. 3. Promissory Estoppel a. For promissory estoppel, relief may sometimes be limited to restitution or to damages or specific performance measured by the extent of the promisees reliance rather than by the terms of the promise. R2d 90 comment d.

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i. Types of Damages a. Out-of-Pocket Expenses 1. The language of R2d 90 allows a court, in its discretion, to award expectation (or some other kind of) damages or to limit damages for a promissory estoppel claim to out-of-pocket expenses. Walser v. Toyota. a. Some courts adopt a strict view that only actual reliance damages are recoverable. b. Other courts have often awarded lost profits or other expectation damages in promissory estoppel cases rather than limiting damages to Ps reliance interest (except where such damages fail one of the requirements like certainty or foreseeability). c. Out-of-Pocket Expenses = difference between the amount paid and the actual (remaining) value of the goods purchased. b. Land 1. Courts generally award specific performance in promissory estoppel cases involving land. See R2d 90 illustration 11. c. Subcontractors 1. The damages for relying on a subcontractors price quote used in a bid is generally the difference between Ds price quote and the price P had to pay another subcontractor for the goods or services (this appears to be conventional expectation-based damages regardless of what the court calls it). C. Restitutionary Damages 1. Restitution in Favor of Non-breaching Party a. Breach of K i. On a breach by non-performance that gives rise to a claim for damages for total breach or on a repudiation, the injured party is entitled to restitution for any benefit that he has conferred on the other party by way of part performance or reliance. R2d 373(1). a. However, the injured party has no right to restitution if he has performed all of his duties and no performance by the other party remains due other than payment of a definite sum of money for that performance. R2d 373(2). ii. A party injured by a breach of K may recover both restitution and reliance damages. CBS v. Merrick. b. Rescission of K i. Rescission and Restitution May Have Two Meanings: a. When used in the context of a voidable or mutually rescinded K, rescission and restitution means that a K is treated as void ab initio 1. If P sues for rescission and restitution, he can recover only those benefits that he has conferred on D. R2d 370. b. On the other hand, a party seeking rescission and restitution in a breach of K action does not seek to undo the K from its beginning. 1. The non-breaching party may then recover both restitution and reliance damages as under any other breach of K: the purpose of the

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damages is to restore P to the situation existing before the K was made. c. Illegal or Void K i. Restitution is the only recovery available when the K is illegal or void from its inception. d. Where Lost Profits are Speculative i. P may request restitution in a breach of K action as a substitute measure of lost profits where the true measure of lost profits would be purely speculative. 2. Restitution in Favor of the Breaching Party a. C/L Rule: Defaulting party on a K is denied recovery by way of restitution and forfeits any partial performance. b. Modern Rule R2d 374, UCC 2-718 i. The party in breach is entitled to restitution for any benefit that he has conferred by way of part performance or reliance in excess of the loss that he has caused by his own breach. R2d 374(1). a. However, the breaching party is not entitled to restitution if: 1. The parties have agreed that the partial performance should be retained by the non-breaching party as liquidated damages; and 2. The forfeiture is reasonable in the light of the anticipated or actual loss caused by the breach and the difficulties of proof of loss. R2d 374(2); or 3. If a party intentionally performs in a way that is materially different from what he promised, even if such performance benefits the other party. R2d 374 comment b. b. Limit on Recovery R2d 374 comment b 1. When a party has committed material breach, recovery should be limited to the lesser of either: a. The value of the benefits conferred; or b. Ds increase in wealth. 2. In no case will the party in breach be allowed to recover more than a ratable portion of the total K price where such a portion can be determined. R2d 374 comment b and illustration 3. 3. Any damages suffered by the non-breaching party are deducted from the restitutionary award. R2d 374(1). ii. A defaulting purchaser of goods is entitled to restitution for amounts he has paid in excess of the damages he caused. UCC 2-718(2). 3. Restitution where K Is Unenforceable a. If the performance obligations imposed by the K have been discharged for some reason, such as incapacity or impracticability, either or both of the parties may be entitled to restitutionary relief: i. Restitution when K is unenforceable because of S.O.F. R2d 375. ii. Restitution when K is voidable because lack of capacity, mistake, misrepresentation, duress, undue influence, or breach of fiduciary duty. R2d 376. iii. Restitution when K is discharged due to impracticability, frustration of purpose, or failure of condition. R2d 377.

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4. Quantum Meruit (unjust enrichment) a. Measure of Restitutionary Interest i. Restitutionary interest may be measured (as justice requires) by either: a. Reasonable value to the other party of what he received in terms of what it would have cost him to obtain it from a person in the claimants position; or b. The extent to which the other partys property has been increased in value or his other interests advanced. R2d 371 ii. Restitutionary Reliance Damages a. If a K was discharged due to impossibility, courts historically measured damages in restitution by the benefit to D; expenditures that did not confer any benefit were not recoverable. b. Some commentators argue that courts should award reliance damages when the K is discharged for impracticability or some other cause. 1. R2d 371 comment b provides that the measure of recovery excludes expenditures to the extent that they conferred no benefit. 2. However, R2d 158 and 272 allow a court to award reliance damages when a K is discharged for mistake and impracticability, respectively. iii. Certainty a. In order to estimate damages for restitution, an expert may testify as to the most likely dollar amount that has been suffered if his testimony is relevant and based on a reliable methodology. Ventura v. Titan. b. Restitution After K Held Invalid i. An action for unjust enrichment may arise where a K is held unenforceable due to failure of consideration, fraud, mistake, incapacity, impossibility, duress, and situations where it would be morally wrong for one party to enrich himself at the expense of another. c. Where Performance Not Covered in a K i. Where an express K exists, there can be no implied-in-law K for the same subject matter. However, one may recover for performing extra services not specified in the original K or if one confers a benefit unknowingly or unwillingly. D. Specific Performance 1. In the Anglo-American legal tradition, specific performance is not a remedy to which P is automatically entitled, even when an unexcused breach has been clearly established. a. Law Acted In Rem (against Ds property) i. The typical judgment at C/L declared that P recover from D a sum of money, which in effect imposed on him a new obligation as redress for the breach of the old. If the sum was not paid, a writ of execution would issue empowering the sheriff to seize and sell so much of Ds property as was required to pay P. b. Equity Acted in Personam (against Ds person) i. Under the influences of cannon law, decrees in equity came to take the form of a personal command to D to do or not to do something. If he disobeyed, he could be punished not only for criminal contempt, at the instance of the court, but also for civil contempt, at the instance of P.

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ii. Adequacy Test a. To prevent encroachment by the chancellor on the powers of C/L judges, a test was developed whereby equity would stay its hand if the remedy at law was adequate. b. Money damages awarded by the C/L courts were ordinarily adequate. 1. Equitable remedies were readily characterized as extraordinary. iii. Discretionary Relief a. Since the chancellor was to act according to conscience, he might withhold relief where considerations of fairness or morality dictated. c. Our courts, like civil law countries, will not undertake to coerce a performance that is personal in nature. d. Our courts have also been reluctant to order specific performance where difficulties of supervision or enforcement are foreseen. e. The practical exigencies of drafting decrees to guide future conduct under threat of contempt have also moved courts to require that K terms be expressed with somewhat greater certainty if specific performance is to be granted than if damages are to be awarded. f. Although a not ordinarily granted, the current trend is clearly in favor of the extension of specific relief. i. Maybe because of the historical division of law and equity or because of the harshness of the penalty (contempt) for failure to comply with a specific performance decree. 2. Reasons Courts Award Equitable Relief R2d 360 a. In determining whether the remedy in damages would be adequate, the following circumstances are relevant: i. Difficulty in proving damages with reasonable certainty; ii. Difficulty in procuring a suitable substitute performance by means of money awarded as damages; and iii. Likelihood that an award of damages could not be collected. b. Other factors a court may consider: i. Hardship to D or others; ii. Hostility to the merits of Ps case; or iii. Values such as freedom of speech or freedom from compulsory service. 3. Substantial Terms Open for Negotiation a. Some courts will not grant specific performance of a K in which some (material) terms are left for further negotiations by the parties or which would require a great deal of supervision by the court. i. Specific performance or an injunction will not be granted unless the terms of the K are sufficiently certain to provide a basis for an appropriate order. R2d 362. b. Other courts hold that specific performance will not be denied merely because the parties have left some issues to be agreed on in the future, particularly when the parties have agreed on all material terms and other equitable factors are present (e.g., when a K has been partly performed by P, and D has received and enjoys the benefits thereof, and P would be virtually remediless unless the K were enforced). City Stores v. Ammerman.; R2d 362 comment b.

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4.

5.

6.

7.

i. On terms to be agreed upon = a good faith stipulation that D will in fact agree with P upon reasonable terms and not arbitrarily refuse to proceed with the K. Substantial Supervision by the Court a. Traditionally, equity courts have refused specific performance where the decree would require extensive supervision. b. The modern trend is that specific performance is granted unless the difficulties of supervision outweigh the importance of specific performance to P. R2d 366. i. The fact that D may make more money by breaching with P and performing with a third party is not a reason for denying specific performance. Unfairness / Unclean Hands R2d 364 a. Specific performance or an injunction will be refused if such relief would be unfair because: i. K was induced by mistake or by unfair practices; ii. Relief would cause unreasonable hardship or loss to the party in breach or to third persons; or iii. Exchange is grossly inadequate or the terms of the K are otherwise unfair. b. Specific performance or an injunction will be granted in spite of a term of the agreement if denial of such relief would be unfair because it would cause unreasonable hardship or loss to the party seeking relief or to third persons. Land / Real Estate / Construction of a Building a. Inadequate / Impracticable Remedy at Law i. Where specific performance is granted, the essential criterion is not the subject matter of the K, but rather the inadequacy or impracticability of the remedy. a. Inadequacy 1. Ks involving interests in land (however ordinary) or unique chattels generally are specifically enforced because the propertys unique and peculiar value make damages at law for breach of the K (money) an inadequate reasonable substitute. 2. Specific performance has traditionally been available to both buyers and sellers of land. R2d 360 comment e. a. Some courts have denied specific performance to the would-be seller of land, however, on the ground that monetary damages will adequately compensate for the purchasers breach. b. Impracticability 1. Where the property is unique, it may also be impracticable to ascertain its fair market value to be compensated in money. b. Extensive Supervision of the Court i. Ordinary building Ks are unlikely to be specifically enforced because of the difficulties of supervision and because construction services can readily be purchased on the market with a money damages award. ii. The modern trend is that courts are more willing than they were to decree specific performance in cases where some degree of service or labor will have to be performed by D. UCC

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a. Specific performance may be decreed where the goods are unique, or in other proper circumstances. UCC 2-716. i. The section in intended to continue in general prior policy but with a more liberal attitude than some courts have shown toward granting specific performance of Ks for the sale of goods. UCC 2-716 comment 1. b. Absent special circumstances, courts are almost certain to deny specific performance if the goods are readily available on the market; in that case, cover by the buyer plus a suit for damages (UCC 2-712) will normally be an adequate remedy. 8. Agreement to Lend Money a. Courts tend to regard money as always available on the market; therefore, Ks to lend money are not generally specifically enforceable because a damage remedy (increased cost of a substitute loan) would necessarily be an adequate remedy. b. Some courts, however, have been more willing to entertain the notion that specific enforcement may be necessary to afford meaningful relief in such cases, especially when P is unable to obtain alternative financing and lenders breach would have consequences that are difficult to monetize. 9. Personal Services a. Specific Performance R2d 367(1) i. For practical, policy, and constitutional reasons, courts generally refuse to order an individual to perform a K for personal services. a. Courts would encounter inherent difficulties in supervising the performance of uniquely personal efforts. b. 13th Amendment prohibits involuntary servitude. ii. First-Refusal Rights a. Outside the personal services area, the usual equitable remedy for breach of a first-refusal clause is to order the breaching party to perform the K with the person possession the first-refusal right. b. However, when personal services are involved, this would result in an affirmative injunction ordering D to perform for P, which cannot be granted. iii. Reinstatement of an Employee a. Courts have traditionally been unwilling to force an employer entity to specifically perform where it breached an employment K. b. Some courts order reinstatement as a remedy, especially where a statute provides for it (e.g., for violation employment discrimination law). b. Injunction i. Where an employee refuses to render services to an employer in violation of an existing K, an injunction may issue to prevent the employee from furnishing those services to another person for the duration of the K, if: a. The services are unique or extraordinary (e.g., entertainers or athletes with exceptional knowledge, skill, or ability); b. Irreparable harm will befall the employer; c. The restrained engagement would have been for a competitor of P; and d. The employee either expressly or by clear implication agreed not to work elsewhere for the period of his K.

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ii. An injunction against serving another will not be issued if its probable result will be to: a. Compel an undesirable performance involving personal relations; or b. Leave the employee without other reasonable means of making a living. R2d 367(2). iii. Some states limit injunctive relief to situations where Ks provide for minimum amount of compensation (e.g., CA = $9,000 to $30,000/yr.) or only enforce personal services Ks for a limited term (e.g., CA = 7 yrs.). c. After K Term Ends (Non-Compete Agreement) i. Injunctive relief is generally not available at the behest of the employer after the term of the K ends, unless: a. Employee is threatening to disclose trade secrets or commit another tortious act; or b. Employee has expressly agreed no to compete with the employer following the term of the K, and: 1. Specific performance is necessary to protect trade secrets, customer lists, or goodwill of the employers business; or 2. Perhaps, the employer is exposed to special harm because of the unique nature of the employees services. c. But, an otherwise valid covenant will not be enforced if it is unreasonable in time, space, or scope or would operate in a harsh or oppressive manner. ii. Weighing of Policies: a. Protection of employer from unfair or illegal conduct; b. Promoting uninhibited competition for services in the marketplace; c. Allowing a worker to earn his livelihood. E. Agreed Remedies 1. Settlement a. Absent some element of fraud, duress, or mistake, an agreement between the parties to compromise, or settle, their dispute will be final with no occasion for judicial adjustment. b. The parties may also agree on the damages and litigate only the question of whether the conduct (or lack thereof) amounted to an unexcused breach. 2. Stipulated Damages Clause a. Liquidated Damages Provision (Enforceable) i. Liquidated damages is the sum a party to a K agrees to pay if he breaks some promise, and which, having been arrived at by a good faith effort to estimate in advance the actual damages that will probably ensue from the breach, is legally recoverable as agreed damages if the breach occurs. b. Penalty (Unenforceable) i. A penalty is the sum a party agrees to pay in the event of a breach, but which is fixed, not as a pre-estimate of probable actual damages, but as a punishment, the threat of which is designed to prevent the breach. Parties to a K may not generally fix a penalty for its breach; such a provision in unlawful. c. Subjective Intent Test (Old)

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i. Historically, whether the parties intended the provision to act as a penalty was considered by a court in addition to the objective standard of reasonableness, but the modern rule is to only look at reasonableness. d. Objective Reasonableness Test i. Restatement Rule 356(1) a. Damages for breach by either party may be liquidated in the agreement but only at an amount that is reasonable in the light of: 1. The anticipated or actual loss caused by the breach; and 2. The difficulties of proof of loss. b. A term fixing unreasonably large liquidated damages is unenforceable on grounds of public policy as a penalty. c. Anticipated and actual damages and difficulty of proof of loss are not strict requirements but rather factors for a court to weigh in deciding whether the clause is a penalty. 1. The greater the difficulty either of proving that loss has occurred or of establishing its amount with requisite certainty, the easier it is to show that the amount fixed is reasonable. ii. UCC Rule 2-718(1) a. Damages for breach by either party may be liquidated in the agreement but only at an amount which is reasonable in the light of: 1. The anticipated or actual harm caused by the breach; 2. The difficulties of proof of loss; and 3. The inconvenience or non-feasibility of otherwise obtaining an adequate remedy. b. A term fixing unreasonably large liquidated damages is void as penalty. iii. Time for Determining Reasonableness / Comparison to Actual Damages a. SPLIT: Courts are divided on the question whether a clause should be examined for reasonableness from the time the K was made or after the breach. 1. Traditional Rule: Clause should be judged as of the time the K was made. a. Even total absence of loss or injury might be irrelevant under this rule. i. A number of courts have held, however, that an unconscionably disproportionate actual damage may be used to evaluate the reasonableness of the pre-estimate or that the lack of actual loss or injury may make the clause invalid as a penalty. 2. Modern Trend: Assessing reasonableness either at the time of K formation or at the time of the breach. a. SPLIT in Interpretation: i. Some courts hold that a clause should be denied enforcement if it is unreasonable in light of the actual harm even if it was reasonable at the time of K formation.

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ii. Other courts hold that the clause should be upheld if it was reasonable either in light of anticipated harm or in light of actual harm. iv. Burden of Proof / Question of Law a. Most courts hold that a stipulated damages clause is presumptively valid and place the burden of proof that the clause is unreasonable on the party seeking to challenge it. 1. Courts regularly enforce provisions in Ks between sophisticated parties represented by counsel because the problem of unconscionability is less prevalent. 2. The best case for enforcement is one in which it appears that Ds breach has inflicted on P an injury that is in the circumstances impossible or at least difficult to quantify with any reasonable accuracy. b. The decision whether a stipulated damages clause is enforceable is a question of law for the court. v. Gross Receipts as a Measure a. Damages based on gross receipts run the risk of being found unreasonable because generally gross receipts (unlike loss of net profits) do not reflect actual losses incurred because of the breach. Wassermans v. Twp. of Middletown. b. Stipulated damages should be merely speculative, possible, or imaginary or provide a windfall to the non-breaching party. e. Delay in Completion Damages i. Clauses providing for liquidated damages in the event of delay in completion are common in construction Ks; such clauses typically measure the amount recoverable by some daily or weekly rate, with perhaps an outside limit, and are usually held to be enforceable in light of the various kinds of injuryboth tangible and intangiblethat can result from such delays. a. Occasionally a clause will be held to provide a measure of damages so far in excess of any injury conceivably resulting from such delay that it amounts to a penalty and will not be enforced. f. Late Fees i. In light of the laws tendency to assume that money is always available in the marketplace (at market rates of interest) and the conventional requirement that liquidated remedies be in lieu of damages that are difficult to compute, provisions calling for late fees or other charges on late payments of money (instead of or in addition to interest) are generally invalid as penalties. g. Employment Ks i. Because of the tendency of courts not to enforce personal services Ks by specific performance or injunction, employment Ks often contain liquidated damages clauses, which could operate either during the term of the K or as part of the post-employment covenant not to compete. a. Of course, such clauses must still survive judicial determination of whether they operate as a penalty, and if attached to a covenant not to compete, they must be reasonable in scope, time, and area.

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b. Provision for liquidated damages will not preclude a court from granting injunctive relief if warranted. h. Real Estate Ks i. Courts are split whether to order specific performance of a K for the sale of land if the parties have included a liquidated damages clause in the K. i. Mitigation i. Courts may award a non-breaching party full liquidated damages without offset for mitigation. a. Liquidated damages may compensate the employee for damage to reputation or other intangible losses from breach. b. Posner explains that mitigation is inconsistent with the underlying premise that such clauses allow parties to fix the amount of damages with certainty. c. However, failure to produce evidence of mitigation may preclude a determination of actual harm, which may be necessary to determine whether amount of liquidated damages was reasonable. j. Consumer Ks i. Where consumer transactions are concerned, statutes or local laws sometimes limit a sellers ability to enforce cancellation fee provisions. k. Limitation of Damages i. Fixing an unreasonably small amount of damages might be unenforceable as unconscionable. R2d 356 comment a; UCC 2-718(1) and comment 1. ii. A limitation of damages clause could be invalid on the grounds of unconscionability but is not examined under the same reasonableness test as a liquidated damages clause. UCC 2-719. iii. Most courts uphold limitation of damages clauses in Ks between consumers and home burglar alarm companies. 3. Mandatory Arbitration Clauses a. Federal Arbitration Act i. A written provision in a K evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such K shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any K. ii. Any doubts regarding the scope of the arbitrable issues should be resolved in favor of arbitration. iii. The FAA leaves no place for the exercise of discretion by district courts. b. Statutory Claims i. Courts are split on the enforceability of mandatory arbitration clauses for claims arising under federal statutes, like Title VII. c. Genesco Test i. First, a court must determine whether the parties entered into a valid arbitration agreement; a. FAA does not require parties to arbitrate when they have not agreed to do so. b. While the FAA requires that agreements to arbitrate be in writing, it does not require the writing to be signed by the parties.

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c. The states laws on K formation (and modification of Ks) will determine whether the parties have agreed to arbitrate. 1. Under Connecticut law, an employee does not accept a modification to an implied, at-will, unilateral employment K merely by continuing to perform, if the modification materially changes a legitimate expectation that the employee had upon commencement of the employment. Phillips v. CIGNA. ii. Second, it must determine whether the dispute between the parties falls within the scope of the arbitration clause; iii. Third, if federal statutory claims are asserted, the court must determine whether Congress intended the claims to be nonarbitrable; and iv. Forth, if the court concludes that some, but not all of the claims in the case are arbitrable, it must then determine whether to stay the balance of the proceedings pending arbitration. d. Commercial Arbitration i. Although courts of an earlier day were extremely hostile to Ks providing for arbitration, regarding this as an attempt to oust them of their rightful jurisdiction, this attitude has given way to one that encourages arbitration as a means of relieving congested court dockets. a. 1925 Federal Arbitration Act and 1955 Uniform Arbitration Act (adopted by 30 jurisdictions) have changed common law rules dealing with arbitration. ii. While some types of disputes are not subject to arbitration, the courts have been broadening the scope of matters subject to arbitration. iii. American Arbitration Assoc. (AAA) Procedure: a. Demand for Arbitration and Payment of the Fee 1. Statement of the nature of the dispute; 2. Amount involved (usually determines the fee); 3. Remedy sought; and 4. Hearing locale requested. b. Answer or Counterclaim c. Proceeding to Compel Arbitration (if necessary) 1. Court order compelling the other party to arbitrate; 2. An action to stay an arbitration proceeding; or 3. A defense to a claim in court requesting a stay pending arbitration. d. Selection of an Arbitrator 1. List method attempts to appoint an arbitrator (usually not a lawyer but a professional in the industry) in accordance with the parties preferences, if not, AAA will choose one. e. The Hearing 1. Discovery generally is not allowed; 2. Arbitrator may subpoena witnesses or documents; 3. Arbitrator may allow taking deposition of witnesses; 4. Any relevant evidence may be considered without regard to the Federal Rules of Evidence; 5. The matter may be submitted entirely in writing without a live hearing.

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f. The Award 1. Typically does not state reasons, just final judgment. 2. May provide for any legal or equitable remedy, including specific performance. g. Review 1. Extremely limited grounds for vacating an award. 2. An award cannot be overturned on the ground that it is contrary to the law or evidence. 3. FAA provides the following bases for judicial review (in which case the court may order a re-hearing): a. Award was procured by corruption, fraud, or undue means; b. Evident partiality or corruption in the arbitrator; c. Misconduct by the arbitrator that prejudices one side; d. Arbitrator exceeded or did not execute his powers; h. Confirmation 1. If the agreement so provides, the prevailing party may seek judicial confirmation of the award, the effect of which is to make the award a judgment of the court.

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